I am looking at a Tax Court case.
It does not break any new ground, but there is a twist
I do not remember seeing before.
Michael Torres and Elizabeth Ruzendall founded an S
corporation (Water Warehouse).
In 2016 Michael found himself in a bad way
health-wise. Elizabeth was around, though, even though she was no longer an
owner. She ran the company in Michael’s absence.
It must have been a sweet gig, as Water Warehouse
issued her a $166,494 Form 1099 for 2016.
Here is the oddball fact: Michael could not read or
write. He was sick for so long, however, that he had time to learn.
Good for him.
In 2017 he came across the Form 1099. He could now
read.
In 2018 he filed civil suit against Elizabeth.
Both the company’s and Michael’s personal 2016 tax
returns were due in 2017. That did not happen, and both returns were filed in
2018.
Remember that an S corporation normally does not pay its
own taxes. Instead, the S income would be included on Michael’s personal
return, and he would pay tax on the sum.
Michael amended the 2016 S corporation return to
subtract the $166,494 paid Elizabeth. Amended returns take an explanation, and
it appears that the word “theft” may have come up.
As the corporate income went down, Michael’s personal
income would simultaneously go down. Michael was now expecting a refund for
2016.
The IRS told him to pound sand.
And off to Court they went.
Embezzlement or theft are maddening topics in the tax
Code.
A key question was whether a theft even occurred. When Elizabeth was running the show in 2016, Michael told her to take “what she felt was her pay.”
Be fair: Elizabeth could easily argue that she had done
that.
Except she testified to taking the funds without Michael’s
authorization.
And then you have the hurdles of the tax law itself.
The Code says that a theft is deductible when
discovered.
Matthew discovered the theft in 2017.
He amended the 2016 corporate and personal tax
returns.
That were due in 2017.
But filed late in 2018.
When was the theft discovered?
That would be 2017.
It cannot go on a 2016 return. It could go on a 2017
return, though.
Michael struck out. He claimed the theft a year early.
COMMENT: Once tax year 2016 became an issue with the IRS, he should have filed a protective claim for 2017. The purpose of the claim would be to keep the 2017 tax year open if the theft deduction in 2016 went against him.
The IRS however marched on: it wanted penalties.
I get it: he failed to file those 2016 returns on
time.
However, the penalty can be abated for reasonable
cause.
The Court said the IRS had reached too far. Michael
had been sick for an extended period of time. He hired a new accountant upon
learning of the 2016 issues. He taught himself to read and write. He
could now review his own accounting records rather than having to rely on
others.
It sounded reasonable to the Court.
To me too.
This is the first time I can remember somebody
receiving penalty abatement citing illiteracy.
However, it is probably more correct to say that Michael
received abatement for becoming literate. I would say the Court liked him.
Our case this time was Torres v Commissioner,
T.C. Memo 2021-66.
