A CPA Takes Tax Advice

 

The facts are not difficult. In fact, they are rather straightforward.

What puzzles me is the player:

Mr. Igboke has been a certified public accountant for more than 30 years and regularly prepares tax returns for his clients. He knows how the federal income tax rules work ….”

I get it: not all CPAs do taxes. Some do taxes, but so few and infrequent as to not count. I used to work with a CPA - since retired - who was a career auditor. He could run circles around me when it came to reports and disclosures and such. He however prepared two returns a year, and his personal return was one of them. He had me review the other.

Mr. Igboke prepared taxes, we are told.

Let’s go through it.

Mr. and Mrs. Igboke (Igboke) lived in Long Beach, California. In 2003 they borrowed from Bank of America. They ran into financial issues not long after, and in 2006 their loan somehow wound up with Select Portfolio Servicing (SPS).

In 2020 Igboke refinanced with a credit union; the mortgage servicing was done by Cenlar.

Let’s go forward one year.

Igboke claimed a mortgage interest deduction of $47,119 on his joint 2021 individual tax return.

Problem: Cenlar issued a Form 1098 for $18,411.

Not the hardest thing for IRS computers to match.

The IRS sent notices. Back and forth they went, to no avail. In 2024 the IRS issued a Notice of Deficiency (called a NOD or sometimes SNOD).

Igboke filed with the Tax Court.

A 30-year CPA with some tax experience. I have no idea if this was his first time in Tax Court, but I am nonetheless expecting a ball with some movement over the plate.

Igboke provided the Court with:

(1)  A “substitute” 2021 Form 1098 from SPS

(2)  An explanatory letter from SPS

Wait, I thought SPS was paid-off in 2020?

Here is the Court on the 1098:

It states in box 1 that Mr. and Mrs. Igboke paid $71,618 of mortgage interest in 2021 …”

Here is the Court on the letter:

Dear Henry Igboke: SPS is in receipt of your recent request for information about the account. Our records show that for calendar year 2021, you paid a total mortgage interest of $31,635.”

I admit: I am not following the numbers:

(1)  The unexplained mortgage interest on the 2021 return was $28,708 ($47,119 – 18,411).

(2)  Then we have a $71,618.

(3)  And next we have a $31,635.

These numbers are parachuting from the sky.

The Court looked closely at the 2021 Form 1098.

All the numbers on the purported 2021 form are identical to those from 2020, including the interest paid and loan balance. But, on the purported 2021 form, the year 2020 has been replaced with 2021, and there appear to be irregular photocopier markings around the year.”

Oh oh.

The Court looked at the SPS letter:

… SPS’s recordkeeper could not find copies of either document in SPS’s records.”

As Ricky would say: someone has some explainin’ to do.

Igboke admitted he had no outstanding loan with SPS and paid no interest in 2021.

Nahhhh, really?

Igboke asserted that SPS sent the Form 1099 because they were unable to deduct the full $71,618 of interest paid in 2020.

QUESTION: How would SPS know this?

SPS told him that he could carry over some portion of that undeducted interest from 2020 to 2021.

COMMENT: And who does he get his medical advice from: Tik Tok?    

Folks, the rules for deducting interest expense can get complicated.

It helps to categorize the interest: investment interest is deducted this way; mortgage interest that way, and vehicle loan interest yet another way. It gives some order to the rules.

Some interest can carry over from year to year. Most interest cannot. You know which interest cannot?

Mortgage interest cannot.

It has been that way since before I heard of accounting.

Here is the 2013 Smoker tax case:

It is well settled that a cash basis taxpayer … is allowed a deduction for interest paid during the year in cash or its equivalent.”

In other words: show me the money.

Back to the Court:

We do not credit Mr. Igboke’s explanation.”

… the discrepancies noted above strongly suggest that these documents are not authentic and were created for the purposes of supporting the Igboke’s claimed deduction.”

This could have gone much worse.

I would have expected heightened penalties for a 30-year CPA.

Maybe a visit from the IRS Office of Professional Responsibility.

Or contact from the California State Board of Responsibility.

Worst case: all of the above.

Igboke lost the deduction, of course, but he may have been lucky to even survive this.

Our case this time was Igboke v Commissioner, T.C. Docket 12275-24, dtd 6.3.26.

A House And A Specialized Trust

I saw a QPRT here at Galactic Command recently,

It had been a while. These things are not as common in a low interest rate environment.

A QPRT (pronounced “cue-pert”) is a specialized trust. It holds a primary or secondary residence and – usually – that is it.

Why in the world would someone do this?

 I’ll give you a common example: to own a second home.

Let’s say that you have a second home, perhaps a lake or mountain home. The children and grandchildren congregate there every year (say summer for a lake home or the holidays for a mountain home), and you would like for this routine and its memories to continue after you are gone.

A couple of alternatives come immediately to mind:  

(1)  You can bequeath the property under will when you die.

(2)  You can gift the property now.

Each has it pros and cons.

(1) The property could continue to appreciate. If you have significant other assets, this appreciation could cause or exacerbate potential estate taxes down the road.

(2) You enjoy having and using the property and are not quite ready to part with it. You might be ready years from now - you know: when you are “older.”

A QPRT might work. Here is what happens:

(1) You create an irrevocable trust.

a.    Irrevocable means that you cannot undo the trust. There are no backsies.

(2) You transfer a residence to the trust.

a.    The technique works better if there is no mortgage on the property. For one thing, if there is a mortgage, you must get money into the trust to make the mortgage payment. Hint: it can be a mess.

(3) You reserve the right to use the property for a period of years.

a.    This is where the fancy planning comes in.

b.    It starts off with the acknowledgement that a dollar today is more valuable than a dollar a year (or years) from now. This is the “time value of money.”

c.    At some point in time the property is going to the kids and grandkids, but … not … right …now.     

d.    If the property is worth a million dollars today, the time value of money tells us that the gift (that is, when the property goes to the kids and grandkids) must be less than a million dollars.  

e.    There is a calculation here to figure out the amount of the gift. There are three key variables:

                                               i.     The age of the person making the gift

                                             ii.     The trust term

                                           iii.     An interest rate

A critical requirement of a QPRT is that you must outlive the trust term. The world doesn’t end if you do not (well, it does end for you), but the trust itself goes “poof.” Taxwise, it would be as if you never created a trust at all.

(4) There is a mortality consideration implicit here. The math is not the same for someone aged 50 compared to someone aged 90.

(5) Your retained right of use is the same thing as the trust term. You probably lean toward this period being as long as possible (if a dollar a year from now is worth less than a dollar today, imagine a dollar ten years from now!). That reduces the amount of the gift, which is good, but remember that you must outlive the trust term. There is push-and-pull here, and trust terms of 10 to 15 years are common.

We also need an interest rate to pull this sled. The government fortunately provides this rate.

But let’s go sidebar for a moment.

Let’s say you need to put away enough money today to have $5 a year from now. You put it in a bank CD, so the only help coming is the interest the CD will pay. Let’s say the CD pays 2%. How much do you have to put away today?

·      $5 divided by (100% + 2%) = $4.90

OK.

How much do you have to put away if the CD pays 6%?

·      $5 divided by (100% + 6%) = $4.72

It makes sense if you think about it. If the interest rate increases, then it is doing more of the heavy lifting to get you to $5. Another way to say this is that you need to put less away today, because the higher interest is picking up the slack.

Let’s flip this.

Say the money you are putting in the CD constitutes a gift. How much is your gift in the first example?

$4.90

How much is your gift in the second example?

$4.72

Your gift is less in the second example.

The amount of your gift goes down as interest rates go up.

What have interest rates been doing recently?

Rising, of course.

That makes certain interest-sensitive tax strategies more attractive.

Strategies like a QPRT.

Which explains why I had not seen any for a while.

Let me point out something subtle about this type of trust.

·      What did we say was the amount of the gift in the above examples?

·      Either $4.90 or $4.72, depending.

·      When did the gift occur?

·      When the trust was funded.

·      When do the kids and grandkids take over the property?

·      Years down the road.

·      How can you have a gift now when the property doesn’t transfer until years from now?

·      It’s tax magic.

But what it does is freeze the value of that house for purposes of the gift. The house could double or triple in value before it passes to the kids and grandkids without affecting the amount of your gift. That math was done upfront and will not change.

A couple of more nerd notes:

(6) We are also going to make the QPRT a “grantor” trust. This means that we have introduced language somewhere in the trust document so that the IRS does not consider the QPRT to be a “real” trust, at least for income tax purposes. Since it is not a “real” trust, it does not file a “real” income tax return. If so, how and where do the trust numbers get reported to the IRS? They will be reported on the grantor’s tax return (hence “grantor trust”). In this case, the grantor is the person who created the QPRT.

(7)  What happens after 10 (or 15 or whatever) years? Will the trust just kick you out of the house?

Nah, but you will have to pay fair-market rent when you use the place. It is not worst case.

There are other considerations with QPRTs – like selling the place, qualifying for the home sale exclusion, and forfeiting the step-up upon the grantor’s death. We’ll leave those topics for another day, though.

A Foreclosure And A Mortgage Interest Deduction

I am looking at a case involving mortgage interest. While I get the issue, I think the taxpayers got hosed.

I am going to streamline the details so we can follow the key points.

The Howlands had two mortgages on their house.

The first mortgage started with Countrywide and eventually wound up with Bank of New York Mellon.

The second mortgage started with Haven Trust Bank and wound up with CenterState Bank.

The house was foreclosed in 2016. It sold for $594,000.

The Howlands owed the following when the house was sold:

            Mellon        CenterState

        Principal      $     $377,060

        Interest     $100,607

        Interest & other    $247,046

The Howlands deducted mortgage interest of $103,498 on their 2016 joint tax return.

Neither bank, however, issued a Form 1098 for mortgage interest.

Allow for a little computer matching (or nonmatching in this case), and the IRS disallowed any interest deduction and assessed penalties to boot.

This story partially happened during the Great Recession of the late aughts. That is when we learned of “too big to fail,” of “ninja” loans and of banks playing musical chairs to survive. Good luck guessing where a given loan would wind up when the music stopped. Perhaps a taxpayer borrowed from someone (let’s call them “A”). A was acquired by B, which was later merged into C and yada, yada, yada. The data platforms between A and B were incompatible, meaning there was a one-way data transfer. The odds that someone years later – especially after the yada, yada, yada - could get back to A were astronomical.

While not clarified in the opinion, I suspect that is what happened here. CenterState Bank was not going to issue a 1098 because it could/would not time travel to determine if their interest calculations were correct. In the absence of such assurance, they were not going to issue a 1098. Or perhaps they were lazy and problem-solving outside a comfortable, numbing rote was a request beyond the pale. I prefer to believe the former reason.

But there was a problem: under the terms of the second mortgage, payments were to be applied first to interest.

COMMENT: Seems to me the Howlands paid interest of some amount.

Let’s focus in on that second mortgage. The money available to repay the second mortgage (after satisfaction of the first mortgage) would have been:

$594,000 – 247,046 = $346,954

There should also have been some interest embedded in the first mortgage, but let’s ignore that for now.

There is $347 grand to pay $377 grand of debt and $100 grand of back interest.

The IRS argued there was not enough money left to cover the principal, much less the interest. That is why the bank did not issue a 1098.

But we know that interest was to be paid first, per the loan agreement.

The Tax Court had to decide.

You know who was not in Court to testify? 

CenterState Bank – the second mortgage holder - that’s who.

Here is the Court:

The record before us is silent as to how CenterState applied the funds received and whether petitioners owe any remaining principal balance. These facts (if favorable) could support a finding that petitioners in fact paid home mortgage interest ….”

True.

However, statements in briefs do not constitute evidence.”

Again, true, but why say it?

Petitioners bear the burden of proof and must show, by a preponderance of evidence, that they are entitled to a home mortgage interest deduction ….”

Oh, oh.

... we conclude that petitioners have failed to meet their burden.”

Sheeshh.

I am not certain what more the Howlands could have done. They were at the mercy of the bank, and the new bank that took the payoff was not the same as the old bank that originated the loan. 

The Tax Court did strike down the penalties. Small consolation, but it was something.

Our case this time was Howland v Commissioner, TC Memo 2022-60.

Can $2 Million Be An Honest Mistake?

 

It is a good idea to look over your tax return before hitting the “Send” button.

Why? Because things happen. Some prep software approximates a black box. It asks questions, you provide numbers and together they go someplace hidden from the eyes of man. Granted, most times the result is just fine. But there are those times ….

Let’s talk about Candice and Randall Busch.

They were preparing their 2017 tax return using a popular tax software, which shall remain nameless. They reached the point where the software wanted mortgage interest. Easy enough. They entered “21,201.25.”

So?

The software did not accept pennies.

This means that 21,201.25 went in as 2,120,125.

That, folks, is a lot of mortgage interest.

BTW one cannot deduct that much mortgage interest on a principal residence. Why? The mortgage interest deduction had been capped for many years as interest paid on the first $1 million of indebtedness. Let’s say someone paid $62,000 on $2 million of principal residence debt. The tax preparer should have caught this and limited the deduction as follows:

         62,000 * 1,000,000/2,000,000 = 32,000

The $1,000,000 cap was further reduced to $750,000 in 2017.

The tax Code has no intention of allowing an unlimited deduction for this type of interest.

Is it ever possible to get past the $1,000,000 (or $750,000) limitation? Well, yes, and it happens all the time. Borrow money on commercial real estate (say a strip mall) and there is no limitation. Borrow money on residential real estate - as long as it is not a principal residence - and there is no limitation. An example would be an apartment complex.  The limitation we are discussing is personal and involves debt on your house.

Back to the Busch’s.

They sound like average folk.

That mistake made their tax refund go through the roof.

They liked that answer.

They sent in the return.

The IRS flagged the return, which was not hard to do when the interest deduction was larger than the allowed debt for purposes of calculating the deduction itself.

The IRS wanted the excess refund back.

The Busch’s would do that.     

Then the IRS also wanted a heavy penalty (the accuracy-related penalty, for the home gamers).

The Busch’s said they wouldn’t do that. An exception to the accuracy-related penalty is reasonable cause, and they had reasonable cause all day long and three times on the weekend.

And what was that reasonable cause, asked the IRS.

It was an “honest mistake,” they replied.

Off to Tax Court they went.

The Busch’s represented themselves, the lingo for which is “pro se.”

The Court acknowledged that mistakes happen. One can get distracted and enter a wrong number, one can transpose, one can get surprised by what a software might do.

But that is not the mistake here.

The mistake here was failing to review the return before sending.

The biggest number on the return – literally – was that interest deduction. It hung over the form like a Big Texan 72-ounce steak on a normal-sized dinner plate.

Here is the Court:

A careful review of the return after it was prepared would most certainly have caught the error; actually, even as little as a quick glance at the return probably would have done so.”

The Busch’s got stuck with the penalty.

The IRS Tests Deductibility Of Business Interest

You may be aware that the new tax law changed the deductibility of your mortgage interest. It used to be that you could borrow and deduct the interest on up to a million-dollar mortgage. That amount has now been further reduced to $750,000, although there is a grandfather exception for loans existing when the law changed.

COMMENT: I have never lived in a part of the country where a million-dollar mortgage would be considered routine. There was a chance years ago to relocate the CTG family near San Francisco, which might have gotten me to that rarified level. I continue to be thankful I passed on the opportunity.

There is also business interest. Let’s say you have a general contracting business. This would be the interest incurred inside the business. Maybe you have a line of credit to smooth out cash flows, or maybe you buy equipment using a payment plan. The business itself is borrowing money.

Business interest has traditionally avoided most of the revenue-rigging shenanigans of the politicians, but business interest got caught this last time. There is now a limit on the percentage-of-income that a business can deduct, and that amount is scheduled to decline as the years go by. You might see the limit referred to as the “163(j)” limitation, which is the Code section that houses it. Fortunately, you do not have to worry about “163(j)” if your sales are under $25 million. If you are over that limit (BTW related companies have to be added together to test the limit), you probably are already using a tax pro.    

Then there is investment interest. In its simplest form, it is interest on money you borrowed to buy stock in that general contracting business. The distinction can be slight but significant: it is interest on monies borrowed to own (as opposed to operate) the business.

There is a limit on the deductibility of investment interest: the income paid you as a return on investment. If the business is a corporation, as an example, that would be dividends paid you. If you do not have dividends (or some other variation of investment income), you are not deducting any investment interest expense. It will carry-over to next year when you get to try again.

I am looking at a case involving an electrical engineer and his sole-proprietor software development company. He was kicking-it out of the park, so he borrowed money to purchase two vacant lots. He also bought two steel buildings, with the intent of locating the buildings on his vacant lots and establishing headquarters for his company.

The business lost a major customer. Employees fled. He sold the steel buildings for scrap.

But he kept paying interest on the loan to buy the lots.

He deducted the interest as business interest, meaning he deducted it in full.

Oh nay-nay, said the IRS. You have investment interest and – guess what – you have no investment income. No deduction for you!

OBSERVATION: The business was still limping along, and as a proprietorship all its numbers were reported on his individual tax return.

The IRS had one principal argument: the buildings were never moved; the headquarters was never established; the land never used for its intended purpose. The “business” of business interest never happened. What he had was either investment interest or personal interest.

Let’s look at the definition of investment interest:

163(d)(5)  Property held for investment.

For purposes of this subsection –

(A)  In general. The term "property held for investment" shall include-

(i)  any property which produces income of a type described in section 469(e)(1) , and

(ii)  any interest held by a taxpayer in an activity involving the conduct of a trade or business-

(I)  which is not a passive activity, and

(II)  with respect to which the taxpayer does not materially participate.

I say we immediately throw out 163(d)(5)(A)(ii), as the taxpayer is and has been working there. I say that he is materially participating in what is left of the software company.

That leaves 163(d)(5)(A)(i) and its reference to 469(e)(1):

     469(e)  Special rules for determining income or loss from a passive activity.

For purposes of this section -

(1)  Certain income not treated as income from passive activity.

In determining the income or loss from any activity-

(A)  In general. There shall not be taken into account-

(i)  any-

(I)  gross income from interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business,

(II)  expenses (other than interest) which are clearly and directly allocable to such gross income, and

(III)  interest expense properly allocable to such gross income, and

(ii)  gain or loss not derived in the ordinary course of a trade or business which is attributable to the disposition of property-

 (I)  producing income of a type described in clause (i) , or

(II)  held for investment.

I am not clear what the IRS is dredging here, other than a circular argument that the interest was not incurred in a trade or business and was therefore held for investment.

The Court said that was an argument too far.

The Court could accept that the properties were not “used” in the trade or business, but it also accepted that the properties happened (the Court used the term “allocable”) because of the trade or business.

The Court allowed the interest as a business deduction.

Our case this time was Pugh v Commissioner.

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.

A Bank Of America Horror Story

A major corporation hounds you almost to the point of death. You sue. You receive a settlement. Is it taxable?

Like so much of tax law, it depends. For example, did the attorney include the magic words that complete the incantation?  

Mr. and Mrs. French received a deficiency notice for their 2012 tax year. The IRS wanted $7,231 in taxes and $1,446 in penalties.

At issue was whether a settlement payment was taxable.

Let’s lay out the story:

·      In 2008 the French’s bought a house.

·      Shortly thereafter Bank of America bought their mortgage.

·      In August, 2009 Bank of America transferred their loan to a subsidiary, BAC Home Loan Servicing.

·      In December, 2009 Mr. and Mrs. French signed a loan modification agreement. The modification was to become effective February 1, 2010.

A loan modification means that that payments were temporarily suspended, an interest rate was changed, the loan term was lengthened and so on. There was a lot of modifications going on around that time.

·      Mrs. French suffered from a very bad back. She was admitted to the hospital in October, 2009 for surgery.

·      From late 2009 into early 2010 Bank of America began calling the French’s on a routine basis, sometimes up to 5 times a day. They were hounding the French’s that their mortgage was about to go into foreclosure.

·      Mr. French was concerned about the effect of these endless calls on his wife. He requested that Bank of America call him on another line, that way he could shield his wife from the stress. Bank of America couldn’t care less. If anything, they were continued receiving multiple calls from multiple people across multiple BAC offices.

·      Mrs. French went into the hospital in December, 2009 and again in January, 2010.

·      In January, 2010 Mr. French spoke with a BAC representative. He explained the loan modification. The representative had no idea what Mr. French was talking about. He explained that – whoever Mr. French sent the modification to – it was not BAC. He instructed Mr. French to redo the paperwork, stop payment on the old check and enclose a new check.

·      After much hassle, Mr. French was told that the modification was accepted and that he should start making payments per the new agreement. He made 10 payments of $1,067.10.

·      When she was finally discharged from the hospital on January 21, 2010, a Bank of America representative called to tell Mrs. French that “officers were on their way to evict” them.

·      On January 23, she started experiencing chest pain and shortness of breath. She went back to the hospital. He suffered two pulmonary emboli, passed away twice but was resuscitated. She was discharged February 4, 2010.

·      BAC did not process the first modification as they promised Mr. French. BAC kept their higher monthly payments and interest rate. To make matters worse, they posted their monthly payments to a non-interest- bearing escrow account and treated the payments as if they were processing fees.

·      In October 2010 BAC told Mr. French that they were not honoring the first modification and that the loan was severely delinquent. They sent a second modification, with conditions and terms injurious to the French’s. For example, the second modification did not even address the 10 payments the French’s had previously sent. Mr. French, his back to a wall, signed the second modification in November, 2010.

·      BAC continued, increasing their monthly payment from $1,067.10 to $1,081.49. In September, 2011, BAC sent the French’s a notice that their checks would not be applied and would instead be returned if not for the higher amount.

Finally, the French’s hired an attorney.

The phone calls stopped.

The French’s sued on six claims, alleging fraud, integration of the first and second loan modifications, punitive damages, additional damages, attorney fees and so forth.

What they did not sue for was personal damages to Mrs. French’s health. 

They settled in 2012. The French’s received $41,333, and the attorneys received $20,666.

The French’s did not report the settlement as income on their 2012 tax return.

The IRS wanted to know why.

The French’s presented several arguments:

(1)  $7,500 of the settlement was not taxable under the “disputed debt” doctrine.

If one party does not agree to the terms of a debt, later settlement does not necessarily mean income. It may mean repayment of amounts improperly charged the borrower, for example. An interesting argument, but the Court noted that the settlement agreement never mentioned disputed or contested debt.

(2)  They were being repaid their own money.

(3)  IRC Section 104(a)(2)

 § 104 Compensation for injuries or sickness.

 (a)  In general.

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include-

(1)  amounts received under workmen's compensation acts as compensation for personal injuries or sickness;

(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

To me, this was – by far – their best argument.

But it is one that BAC would never, ever put in writing.

The Court was however willing to look back to the six claims the attorneys filed for Mr. and Mrs. French. Unfortunately, the only language it found was the following:

… suffered lost time, inconvenience, distress [and] fear, and have been denied the benefit of the loan modification they were promised, and are being charged too much on their loan.”

These, folks, are not the magic words to open the Section 104(a)(2) door. For one thing, the words referred to both Mr. and Mrs. French.

The French’s owed the tax, but the IRS relented on the penalties.

Too bad the attorneys did not run the paperwork past a competent tax practitioner before it was too late.

Our case this time was French v Commissioner, T.C. Summary Opinion 2018-36.