Self-Sabotaging A Penalty Abatement

 

The opinion is two and a half pages.

It is one of the shortest opinions I have seen. That was – frankly – what caught my interest.

Francis Kemegue lost his job in 2017. I do not know details, but he experienced multiple personal and professional setbacks.

He extended his 2017 return.

Gotta be a late file/late payment case. If you are ever in a situation where you are unable to pay your tax, file the return nonetheless. Yes, the IRS will eventually contact you, but they are going to contact you anyway. The penalties for filing a late return are more severe than for filing but not paying.

Kemegue in fact never filed his 2017 return.

Sounds like that job loss debilitated him.

The IRS prepared a tax return for him. This a called a “substitute return,” and the IRS assumes that every known receipt (think computer matching) is taxable and that there are no deductions. The math is bogus, of course. The IRS is not so much trying to prepare your return as to catch your attention.  

He owed with that substitute return.

Of course.

Now he was late file and late pay.

Great.

Kemegue wanted a break.

Go for it.

More specifically, he wanted abatement of the late file and pay penalties.

I would do the same. There is a kabuki dance to this, however. Abating this penalty requires establishment of reasonable cause. The IRS has for a while been (in my opinion) very unreasonable about reasonable cause. However, if Kemegue was seeing a counselor or otherwise under professional care – even if intermittently - he has a decent chance. This would be a superb time to obtain exculpatory letters from his health professional(s) and to polish his storytelling chops.

Kemegue did not do any of this.

He did talk about his job search, including traveling to other states. He even tried to start his own company.

Kemegue, you are missing the plot here.

The Court wanted to know more about his story: shattering setback, evaporating self-confidence, needing help for depression. He fell behind on his tax return because he – you know – fell behind in all areas of his life.

Silence.

Not good.

The Court wanted to know: what was going on that he could travel and search for work but not file that tax return?

Again silence.

You know how this turned out.

Sheesshh.

Our case this time was Francis Kemegue v Commissioner, T.C. Summary Opinion 2023-5.

Travel Expenses When You Have One Client

It is an issue I know well: when are your away-from-home travel expenses deductible?

Granted, this issue has a lot less lift underneath it now that miscellaneous itemized deductions are disallowed, but it can still affect the self-employeds, including partners and LLC members.

What sets it up is the concept of a “tax home.”

This term does not mean what you would first think.

A tax home is primarily an economic concept: where do you earn your paycheck? Depending on that answer, you may or may not have deductible travel expenses.

Say that you live in northern Kentucky. Your job is in San Francisco. Every Sunday you catch a plane out, and every Friday you return home.

COMMENT: I am not making this up. I had a client who did this – for a while. It was a VERY good paycheck.

You do not have deductible travel. You earn your paycheck in San Francisco. You are not travelling away from your tax home. You are travelling away from your residence, but in this case your residence is not your tax home.

Let’s mix it up. Say that you work one week in San Francisco and one week from Kentucky. Have you moved the needle?

You may have.

Let’s mix it up again.

Say you have five clients. One week you travel to San Francisco. Another week you travel to Nashville. One week you stay home and work on your three other clients.

Have you moved the needle?

Yep.

When a taxpayer does not have a permanent place of business but rather is employed by various clients and at different locations, the default rule is that the taxpayer’s residence is deemed the tax home. This is the Zbylut case, and feel free to call me on how to correctly pronounce the name.

I am looking at the Brown case (TC Memo 2019-30).

Brown was based out of Atlanta. He was a business consultant working as a CFO. If you needed his skill set but not a full-time CFO, Brown might be your guy. He had several clients over several years, and in 2012 he picked up a sweet multiyear contract in New Jersey.

Two key facts:

(1)  For 2012 and 2013, his only business income was from New Jersey.

(2)  And wouldn’t you know that the IRS audited his 2012 and 2013 returns.

Brown argued that New Jersey was a temporary gig.

In the sense of eternity, he is right. In real time, however, the contract was for three years. The IRS considers one year to be the demarcation between temporary and indefinite. There is probably no deduction if you go indefinite.

But New Jersey could terminate the contract, argued Brown.

Could but not likely, replied the Court.

Brown then wanted to rely on Zbylut.

The IRS wanted to see other paychecks.

Brown argued that in 2013 he started working one week in New Jersey and one week at home.

The IRS wanted to see his travel and other records.

Which he never provided. Why? Who knows.

He argued that he was working on other clients and that focusing solely on cash received during the period under audit was misfocused.

Yep, I get it. Maybe he could not invoice until a job was complete or materially so. Or some client stiffed him.

The Court paused. Provide us a schedule or calendar with client meetings, work assignments, business-related tasks, correspondence. Help us out here.

That seems reasonable. Surely he can come up with telephone records, exchanged e-mails, any snail mail correspondence….

Brown provided nothing.

Folks, the Tax Court has a long-standing rule-of-thumb:

If you fail to produce documentation in your possession that would be favorable to you, the Court will take the presumption that the documentation, if presented, would be unfavorable to you.

And that is what the Court did: it ruled against Brown.

He did not lose because of uninterpretable technical issues. He lost for the most basic reason: he provided no support or documentation for his position.

And I suspect I know why: he really had only one gig and that gig was in New Jersey. There was no travel as defined in the tax Code. His tax home locked arms with his paycheck and they both moved to New Jersey. It’s OK.

But there is no tax deduction.

We Recently Lost An Employee

What I do for a living can be demanding.

I am thinking about it because we have lost another employee.

Mind you, there is always a good reason to leave: a larger firm, a smaller firm, someone wants to go private and get away from any firm, more predictable hours, a geographic move, … it is endless.

The auditors complain about the insane paper chase that has become their corner of the profession. They spend as much time completing checklists as actually doing any meaningful work. It truly takes an idiot to think that we can prevent the next Enron by checking a box on page 64 of a 98-page checklist.

Let me clue you in: by page 64 the auditor has zoned out.

The key to audit fraud is experience – the one thing the giant firms are not geared to provide. Their economics are based on 1 to 4-year accounting graduates. That is no country for old men. Or women.

Tax has fared no better.

It used to be that accountants would stagger year-ends for their business clients. Some would be June, some would be October. This helped to balance the workload and keep accountants from being crushed. Congress – reminding us that the truly useless become politicians – decided years ago that calendar year-ends were the way to go. They allowed a few exceptions, but the majority of closely-held businesses were herded to a calendar year-end.

BTW individuals also end their tax year on December.

So we have this insane crowding of work into two or so months. Granted, much is extended, meaning that the crowding occurs again when the extensions run out. There is no real reason for it, other than government whim and profligacy.

Why, no … gasp! We cannot possibly allow other-than-December year-ends because that would cause a one-time hit to the Treasury. Ignore the fact that there previously was a one-time boon to the Treasury when businesses went to December. The very pillars of society would fall!

Uh huh.

Congress continues its quest to have every economic transaction in American society reported to the government via a Form 1099 or its equivalent. Oh, and if you would be so considerate to do all this by January 31.

We tie-up at least three paraprofessionals for a good chunk of January with 1099s and payroll reporting. Let’s not go Boston University stupid and pretend this is not an indirect (but substantial) tax on business activity. A tax heaved on us by sociopaths who make $174,000 annually, live in one of the most expensive cities in the country but somehow become multimillionaires on a routine basis.

Uh huh.

Take an IRS that has sought for years to do more with less, meaning that more and more of what it does is automated. This returns us to all those 1099s the government wants, with its computer matching and automated notices.

I would be curious to know how many millions of man-hours are wasted every year by BS notices the IRS sprays out. Some of this used to be resolved internally before mailing a notice, as an IRS employee maybe … just maybe … actually looked at the file. Ah, how innocent we were then.

There are consequences to all this nonsense.

I had a conversation very recently with a CPA firm owner. We are similar in age and background. He was telling me how it is becoming almost impossible to hire, as there either is no one available or what is available is simply not hireable. Given our immediate needs, this was not good news.

Our conversation then expanded to the question of why a young person would pursue the career we ourselves chose years ago. There are so many more career paths now providing competitive income levels without depriving someone of 4 to 5 months of their life. Every year.

He did not want his kids to be accountants. They didn’t.

It is showing up in different ways. Accountancy, for example, remains a popular college major and graduation rates are strong. However, interest in pursuing a CPA credential is declining.

The CPA credential of course is closely associated with a CPA firm. When I was coming through there was a career point one could not pass if one did not have his/her CPA. One could make senior accountant, for example, but not manager without the certificate.

My CPA was not optimistic, arguing that our generation – his and mine – might be the last of its kind. 

I am hearing this opinion repeated by more and more practitioners. It is not uniform, mind you, but it is common.

I do not do gloom, but I also believe that the next generation of accountants will demand more life balance that we - the 50-and-60-year-old crowd – did when it was our turn.

Good for them.

What will it do to the giant CPA firms and their churn-and-burn business models? What will it do to the accounting governing bodies, who seem to represent the largest while seemingly having little interest in entrepreneurial and closely-held businesses the vast majority of CPAs – me included - represent? How about Congress? What if they passed a tax law in December and CPAs refused to work 24/7 for their incompetence?

I wish some of this had happened earlier in my career.

If Your Job Requires It, Can You Deduct It?

I was recently talking with a friend about job opportunities available to him.

Some locations – like New York and L.A. – he dismissed immediately.

Then he mentioned that another location would require him to “suit and tie” every day.

I could not help but laugh. We both worked together in a mandatory “tie” environment, and I have worked in a mandatory “coat and tie” one. I suspect the latter is because the firm was downtown, and the firm wanted to project a certain image as its employees walked about. 

Still, suiting up gets expensive.

Sure would be nice if you could get a tax deduction out of it.

It’s almost impossible.

There is a famous case that laid down three requirements for clothing to be deductible:

(1) The clothing is of a type specifically required as a condition of employment;

(2) It is not adaptable to ordinary day-to-day wear; and

(3)  It is not used for day-to-day wear.

All in all, that seems to cover almost all clothing, unless you wear uniforms or are an astronaut.

But let me give you a few odd situations, and you tell me if there is hope of a tax deduction:

(1) You are a painter and are requested by the union to wear the traditional white-on-white painter’s outfit.

(2) You are a television news anchor and have to dress the part.

(3)  You are a Swedish rock band and wear clothing that looks like it has been dragged and ripped by wild dingoes.

(4) You are a musician and dress like a gypsy (or Welsh witch) for your performances.

There is a fellow who works for Ralph Lauren Corp. The company requires him to wear Ralph Lauren apparel while representing the company. As a consequence he has quite the extensive collection (and investment), and he tried to deduct some of it as a miscellaneous deduction on his Schedule A.

The Tax Court just said no dice. The clothing could be used day-to-day and therefore did not rise to the level of a deduction. The cost and restrictions imposed upon him by his employer were not tax relevant.

In truth, I wonder why he even pursued this matter. There is a case from before I came out of school where an Yves Saint Laurent employee tried the same deduction and failed.

Back to our examples:

(1) No deduction. The clothing could still be worn, although one is unlikely to do so. There may be an argument if the union required you to dress that way. The tax trigger would be more the requirement and less the clothing.

(2) Almost impossible. There is a case involving a news anchor with a wardrobe she considered too conservative for everyday use. She segregated it and wore it only at work. Not only did the Tax Court disallow the deduction, they also assessed penalties.

(3) This was the band ABBA, and they got the deduction. If you google their photographs, it is clear you would not wear that clothing outside of a performance or on Halloween.

(4) This was Stevie Nicks of Fleetwood Mac. She deducted over $40 grand on her 1991 tax return for costumes and hair styling. The IRS disallowed these and selected other deductions on her return. While the matter was docketed for Tax Court, it was returned to IRS Appeals. It was there resolved, and unfortunately tax practitioners (other than Stevie’s tax advisor) do not know how it turned out.

Then for the extreme tax athletes there is the woman who was able to deduct her body makeup, and I freely admit I am not sure what that is. She did not deduct clothing, as she wore none. She was an actress for the Broadway performances of Oh! Calcutta!