No Penalty Abatement When Taxes Not Paid For Years

 

I am looking at a case where the taxpayers wanted penalty abatement for reasonable cause.

I have been cynical for years about the IRS allowing reasonable cause, but let’s read on.

The Koncurats owed for years 2005, 2006 and 2010 through 2016.

CTG: There is a donut in there from 2007 through 2009. I wonder what happened?

For the years at issue Stephen Koncurat owned his own company in the insurance industry. Tamara Koncurat maintained their home and raised four children.

The interest and penalties added up, exceeding $670 grand. To their credit, the Koncurats did not argue the tax due. They did feel, however, that penalty abatement was warranted because “circumstances largely beyond his control” prevented them from meeting their tax obligations.

There were a lot of years involved, though. What were those circumstances?

·      Around 2007 or 2008 Stephen had six rental properties foreclosed.

COMMENT: Got it. That was the Lehman Brothers bankruptcy and the near implosion of the American housing market.

·      From 2010 to 2011 Stephen’s income dropped sharply from over $450K to about $96K.

·      There was a stretch where they could not even afford to make their house payment. Stephen’s father made the payments for them. 

OBSERVATION: This is years after 2005 and 2006, however. I can see going into a payment plan, then negotiating with the IRS to reduce or interrupt payments because of subsequent events cratering one’s income. It is not the easiest thing to do, but it can be done. 

·      Around 2014 or 2015 Stephen broke his back.

·      In 2018 he was diagnosed with cancer and a blocked artery.

·      He thereafter underwent three major surgeries and attended over 100 medical appointments.

He continued to work, as best he could., They reported the following income:

         2005          $274,359

         2006          $251,902

         2010          $462,455

         2011          $95,974

         2012          $71,847

         2013          $109,072

2014          $171,648

2015          $207,398

2016          $314,491                              

I get it. The 2011 through 2013 tax years were aberrant.

I am impressed how well he did during the broken back, cancer and surgery years, though.

Stephen voluntarily paid $1,500 a month to the IRS.

Good.

Starting January 2020.

What? Starting …??

I admit, this is going to be a problem. Unexpected circumstances can knock you off your feet. Maybe you don’t file or pay for a couple of years, but there is a beginning and end to the story. Somewhere in there the IRS – and reasonable cause – expects you to put on your big boy pants and try to comply. Hopefully you can file and pay, but maybe all you can do is file. Fine, then file and request a payment plan. Will the IRS be unreasonable? Of course. What if they want more than you can pay? Then request a Collections Due Process hearing.

The point is: get back into the system.

If you don’t, then reasonable cause – hard to obtain under regular circumstances – takes a step up the difficulty ladder. You now have to present “unavoidable obstacles” to your compliance.

Short of being in a coma or Marvel Universe superheroes destroying your city, that “unavoidable” threshold is going to be near-nigh impossible to meet.

Here is the Court:

·      They have alleged no details sufficient to support a finding that any of the hardships they experienced actually presented unavoidable obstacles.”

·      Further, the Koncurats have not alleged … that they ‘didn’t have [the money] or couldn’t keep [the installment plan] going…’”

·      While the family’s financial troubles were significant at times, the record reflects that they have had consistent access to financial resources throughout the years at issue.”

·      They were … contributing tuition, housing and wedding expenses to children….”

That last one doesn’t make sense for broke people.

·      Stephen Koncurat earned more than one million dollars in income in 2019, and again in 2021.”

So we are not talking about broke people. Broke people do not make a million dollars a year.

The Court wanted to know why – with that million dollars – they did not clean-up their tax debt – or at least a chunk of it – rather than delaying payment and tying up the Court’s time.

There was no reasonable cause for the Koncurats. Heck, one could have looked at the extended failure to pay and instead concluded that there was willful neglect.

Meaning no penalty abatement.

No surprise there.

The Koncurats dug themselves a hole by letting the matter go on long enough to attend high school. The likelihood of reasonable cause over that much time was minimal, but I do think that there was something they could have done to improve their odds.

What would that have been?

Take that $1 million dollars and pay the IRS.

They would then have gone before the Court and argued that they had a bad stretch, causing them to fail in their obligations and run afoul of the tax system. However, when their fortune improved, the first party they took care of was … the IRS.

Would this have allowed reasonable cause? Financial difficulties generally do not lead to eligibility for reasonable cause relief.

But it would not have hurt. It also would have lifted the needle off zero and given the Court something specific to support a taxpayer-favorable determination.  

Our case this time was United States v Koncurat, USDC MD, Case No 1:21-cv-00676.

Exceptions to Early Distribution Penalties

 

What caught my eye about the case was the reference to an “oral opinion.”

Something new, methought.

Better known as a “bench opinion.’

Nothing new, methinks.

What happened is that the Tax Court judge rendered his/her opinion orally at the close of the trial.

Consider that a tax case will almost certainly include Code section and case citations, and I find the feat impressive.

Let’s talk about the case, though, as there is a tax gotcha worth discussing.

Molly Wold is a licensed attorney. She was laid-off in 2017. Upon separation, she pulled approximately $86 grand from her 401(k) for the following reasons:

(1)  Pay back a 401(k) loan

(2)  Medical expenses

(3)  Student loans

(4)  Mortgage and other household expenses

You probably know that pulling money from a 401(k) is a taxable event (set aside a Roth 401(k), or we are going to drive ourselves nuts with the “except-fors”).

Alright, she will have income tax.

Here is the question: will she have an early distribution penalty?

This is the 10% penalty for taking money out from a retirement account, whether a company plan (401(k), 403(b), etc) or IRA and IRA-based plans (SIMPLE, SEP, etc). Following are some exceptions to the penalty:

·      Total and permanent disability

·      Death of the account owner

·      Payments over life expectancy; these are sometimes referred to as “Section 72(t)” payments.

·      Unreimbursed medical expenses (up to a point)

·      IRS levy

·      Reservist on active duty

Then it gets messy, as some exceptions apply only to company-based plans:

·      Leaving your job on reaching age 55 (age 50 if a public safety employee)

Is there a similar rule for an IRA?

·      Withdrawals after attaining age 59 ½.

Why age 55 for a 401(k) but 59 ½ for an IRA?

Who knows.

Molly was, by the way, younger than age 55.

There are exceptions that apply only to a company-based plan:

·      A qualified domestic relations order (that is, a divorce)

·      Dividends from an ESOP

There are exceptions that apply only to an IRA and IRA-based plans:

·      Higher education expenses

·      First-time homebuyer (with a maximum of $10,000)

Yes, Congress should align the rules for both company, IRA and IRA-based plans, as this is a disaster waiting to happen.

However, there is one category that all of them exclude.

Ms Wold might have gotten some pop out of the exception for medical expenses, but that exclusion is lame. The excluded amount is one’s medical expenses exceeding 7.5% of adjusted gross income (AGI). I suppose it might amount to something if you are hit by the proverbial bus.

The rest of the $86 grand would have been for general hardship.

Someone falls on hard times. They turn to their retirement account to help them out. They take a distribution. The plan issues a 1099-R at year-end. Said someone says to himself/herself: “surely, there is an exception.”

Nope.

There is no exception for general hardship.

10% penalty.

Let’s go next to the bayonet-the-dead substantial underpayment penalty. This penalty kicks-in when the additional tax is the greater of $5,000 or 10% of the tax that should have been shown on the return.

Folks, considering the years that penalty has been around, you would think Congress could cut us some slack and at least increase the $5 grand to $10 grand, or whatever the inflation-adjusted equivalent would be.

Ms Wold requested abatement of the penalty for reasonable cause.

Reasonable cause would be that this area of the Code is a mess.

You know who doesn’t get reasonable cause?

An attorney.

Here is the Court:

So I will hold her as a lawyer and as a highly intelligent person with a good education to what IRS instructions that year showed.”

Our case this time was Woll v Commissioner, TC Oral Order.

When Hardship Is Not Enough

Let’s talk a bit about hardship distributions from your retirement plan – perhaps your 401(k).

You may know that you are not supposed to touch this money before a certain age. If you do, not only will there be income taxes to pay, but also a 10% early withdrawal penalty. These are two moving pieces here: one is the income tax on the distribution and another for the 10% penalty.

Here is a question for you:

Let’s say you can withdraw money from your plan for hardship reasons. Does that mean that the penalty does not apply?

The answer is no. One would think that the two Code sections move in tandem, but they do not.

Candace Elaine ran into this in a recent Tax Court decision.

Candace lived in California, and in 2012 she withdrew $84,000 from her retirement plan. She had lost her job in 2009, and she was trying to support herself and family.

The tax Code applies two requirements to the income taxation of hardship withdrawals:

·        On account of an immediate and heavy financial need, and

·        Any amount withdrawn is limited to actual need

An “immediate and heavy financial need” would include monies needed for medical expenses or to avoid foreclosure. In addition, one is not allowed to withdraw $20,000 if the need is only $12,000, with the intention of using the excess for other purposes. 

The plan custodian is the watchman for these two requirements. The custodian is to obtain reasonable assurance of need and inquire whether other financial resources exist. This is a role above and beyond routine administration, and consequently many plans simply do not offer hardship withdrawals.

Candace met those requirements and her plan allowed withdrawals. She reported and paid income tax on the $84,000, but she did not pay the 10% penalty.

The IRS bounced her return. Off to Tax Court they went, where Candace represented herself.

Her argument was simple: I received a hardship distribution. There is an exemption for hardship.

The IRS said that there was not. And in the spirit of unemployed taxpayers trying to support their family, the IRS assessed a penalty on top of the 10% chop.

The Court pointed several exceptions to the 10% early withdrawal penalty, including:

·        Separation from service

·        Disability

·        Deductible medical expenses

·        Health insurance premiums while unemployed

·        Higher education

·        First time purchase of a principal residence

There isn’t one for hardship, though.

Meaning that Candace owed the 10% penalty.

The Court did note that the misunderstanding on the 10% is widespread and refused to assess the IRS’ second penalty.

Why did Candace not just borrow the money from her 401(k) and avoid the issue? Because she had been let go, and you have to be employed in order to take a plan loan.

What if she had rolled the money into an IRA?

IRAs are not allowed to make loans, even to you. The only way you can get money out of an IRA is to take a distribution. This is what sets up the ROBs (Roll-Over as Business Start-Up) as a tax issue, for example.

Candace was stuck with the penalty.

Jurate Antioco's Nightmare On IRS Street

Ms. Jurate Antioco lived in Martha’s Vineyard, where she owned a bed and breakfast with her husband. The B&B was their home. In 2006 they divorced (after 27 years) and sold the B&B for almost $2 million. They used some of the money to pay off marital debt, but over $1 million went to her after she was unable to finish a Section 1031 exchange within the permitted time.

After approximately 1 year, she took the money and borrowed another $950,000 to buy a multifamily in San Francisco. She moved into one unit, moved her 90-something-year-old mother into another and rented the remaining three units as a source of income.

Ms. Antioco made a mistake concerning her taxes, though. She thought that – perhaps because the B&B had been her residence – that she would not owe any taxes. She fell behind in filing her 2006 taxes but did better with 2007. Her accountant informed her that she owed taxes on the sale for 2006. She was unprepared for this, as she had put almost all her money in the multifamily. She filed the tax returns, though.

The IRS of course assessed tax, interest and penalties. It is what they do.

In April, 2009 the IRS sends her a notice of intent to levy. Ms. Antioco has all her money tied up in the multifamily, so she filed for a collection due process (CDP) hearing.  She proposed paying $1,000 per month until she could work out a loan. She explained that her mom was having health issues, she was moving into caregiver mode, and anything more than $1,000 at the moment would cause economic hardship. As a show of good faith, she started paying $1,000 a month.

She contacted other lenders about a loan, but she soon learned that she had a problem. Even though she had considerable equity in the property, her current lender had included a nuclear option in the mortgage giving them the right to foreclose if another lien was put on the building

OBSERVATION: There is a very good reason to request a CDP, as the IRS will routinely file a lien to secure its debt. This could have been very bad for Ms. Antioco.

She goes back to the primary lender, and they tell her that they are not interested in loaning her any more money.

She has a problem.

The IRS sends her paperwork (Form 433-A) and schedules a hearing for September, 2009. The IRS tells her that she simply has to try to borrow before they will consider an installment plan. If she cannot, then proof of that must also be submitted.

She finds another lender and a better interest rate. The new lender will refinance but not lend any new money. Still, a lower payment frees-up cash, so Ms. Antioco decides to refinance. The new lender wants her to put her mom on the deed, which she does by granting her mother a joint tenancy in the property.

She sends her financial information (the Form 433-A), along with supporting bank documentation and a copy of her most recent tax return, to the IRS. She hears nothing.

In November, 2009 she received a notice from the IRS stating that they were sustaining the levy. The notice stated that she had requested a payment plan, but she had failed to provide additional financial information. In addition the IRS completely blew off her economic hardship argument.

Ms. Antioco appealed to the Tax Court. She pointed out that she was never asked for additional financial information, and –by the way – what happened to her economic hardship request?

And then something amazing happened: the IRS pulled the case, admitting to the Court that the Appeals officer had never requested additional financial information and had in fact abused her discretion.

The Court sent the matter back to IRS Appeals, hoping that the system would work better this time.

Uh, sure.

Enter Alan Owyang. The first thing he did was call Ms. Antioco to schedule a face-to-face meeting and review detailed questions. . Ms. Antioco explained that she would call back later that day, as she wanted to collect her documents to help her with the detailed questions. Owyang didn’t wait, and he kept calling her back that same day. At one point her accused her of being “uncooperative’ and that she “put your money where your mouth is.” He added that he had been a witness in her case.

Ms. Antioco was so rattled that she hired an attorney. Sounds like a great idea to me.

Mr. Owyang sent her a letter a few days later, saying that he thought Ms. Antioco had added her mother to the deed to defraud the government and that he also thought she could pay her taxes but “simply chose not to do so.” He asked for all kinds of additional paperwork, but not curiously no new financial information – the very reason the Tax Court sent the matter back to IRS Appeals. 

Her attorney submitted a bundle of information and requested another CDP hearing for April, 2011. He explained to Mr. Owyang that Ms. Antioco’s mother was declining and would (likely) not survive a sale and move from the apartment building. All Ms. Antioco wanted was time – to allow her mom to pass away or to finally get a new loan – after which she would able to pay the balance of the tax. She was willing to pay under a short-term installment plan until then.

Mr. Owyang told the attorney that he would not grant an installment agreement because Ms. Antioco had chosen to transfer the equity in the apartment building by adding her mother to the deed. He could not see another reason for it.

·        Even though he had a letter from the lender stating it wasn’t willing to lend any more money. And to include her mom on the deed if she wanted to refinance.

He refused to consider whether there was any “hardship.”

·        One of the reasons it went back to the IRS to begin with.

He also thought that all the talk about taking care of a 90-something-year-old mom was a “diversionary argument” that he “would not consider.”

·        I am stunned.

Mr. Owyang also contacted the IRS Compliance Division. He said that the government’s interest was in “jeopardy,” and he recommended that the IRS file a manual lien. There were problems with the filing, and Mr. Owyang went out of his way to follow up personally.

In May, 2011 Mr. Owyang filed a supplemental notice of determination, concluding that Ms. Antioco had “fraudulently” transferred the building to her mother. He went all Sherlock Holmes explaining how he had deduced that Ms. Antioco had committed fraud, concealed the transfer, became insolvent because of it and was left without any assets to pay the government. It was his judgement that she could have gotten a loan if she really wanted one, and that Ms. Antioco was a “won’t pay taxpayer” who was using her ailing mother as an “emotional diversion.”

This guy is a few clowns short of a circus.

They are back in Tax Court. The IRS this time sees nothing wrong with Mr. Owyang's behavior. They did however acknowledge that Mr. Owyang never ran the numbers to see if Ms. Antioco was insolvent, and that his determination of fraud was … “flawed.”

But Mr. Owyang had not abused his discretion. No sir!! Not a smidgeon.

The IRS wanted the Court to dismiss the case.

The Court instead heard the case.

The Court went through the steps, noting that the Commissioner can file liens to secure the collection of an assessed tax.  The IRS however must follow procedures, such as notifying the taxpayer, granting a collections appeal if the taxpayer requests one, and so on. The taxpayer had proposed a payment alternative, and the IRS never completed its analysis of her proposed payment plan. The IRS had also failed to consider her complaint of economic hardship.

The IRS did not follow procedure.

The Court then reviewed Mr. Owyang’s behaviors and assertions, refuting each in turn. The Court even pointed out that Ms. Antioco had paid down her tax debt by $88,000 by the time of trial, not exactly the conduct of someone looking to shirk and run. The Court was not even sure what Mr. Owyang’s real reason was for his determination, as his reasons were contradicted by documentation in file, not to mention changing over time.

The Court decided that Mr. Owyang had abused his discretion.

In February, 2013 the Court sent the case back to the IRS again, as the IRS never reviewed whether the $1,000 was a reasonable payment plan.

Back to the IRS. Introduce a new Appeals officer.

Ms. Antioco then filed suit against the IRS for wrongful action – that is, over the behavior of Mr. Owyang. This type of suit is very difficult to win. Ms. Antioco focused her arguments on Mr. Owyang’s abusive behavior.  The District Court determined that this behavior occurred while Mr. Owyang was “reviewing” collection action and not actually “conducting” collection, which barred liability under Section 7433.

OBSERVATION: No, he was “collecting.” What is a lien, if not a collection action?

In June 2013 the IRS finally agreed to an installment payment plan.

In July, 2014 the IRS filed suit to reduce Ms. Antioco’s liability to judgment. Reducing an assessment to judgment gives the IRS the ability to collect long after the 10-year statute of limitations.

Ms. Antioco filed a motion to dismiss.

Her reason for requesting dismissal? The tax Code itself. Code Section 6331(k)(3)(A) bars the IRS from bringing a proceeding in court while an installment agreement is in effect.

The IRS realized it got caught and last month agreed to dismiss.

And that is where we are as of this writing.

For a tax pro, the Jurate Antioco cases have been interesting, as they highlight the importance of following procedural steps when matters get testy with the IRS. From a human perspective, however, this is a study of a government agency run amok.  How often does the IRS get spanked twice by the Tax Court for abuse on the same case?

Ms. Antioco’s mom, by the way, is now 97 years old and suffering from congestive heart failure. Ms. Antioco is herself a senior citizen. May they both yet live for a very long time.