Requesting A Payment Plan With Over $7 Million In The Bank

Sometimes I wonder how people get themselves into situations.

Let’s take a look at a recent Tax Court case. It does not break new ground, but it does remind us that – sometimes – you need common sense when dealing with the IRS.

The Strashny’s filed their 2017 tax return on time but did not pay the tax due.

COMMENT: In and of itself, that does not concern me. The penalty for failing to file a tax return is 10 ten times more severe than filing but not paying. If the Strashny’s were my client and had no money, I would have advised the same.

The 2017 return had tax due, including interest, of over $1.1 million.

COMMENT: Where did the money go? I am curious now.

In June, 2018 the IRS assessed the tax along with a failure-to-pay penalty.

In July, 2018 the Strashny’s sent an installment payment request. Because of the amount of money involved, they had to disclose personal financial information (Form 433-A). They wanted to stretch the payments over 72 months.

COMMENT: Standard procedure so far.

Meanwhile the IRS sent out a Notice of Intent to Levy letter (CP90), which seemed to have upset the Strashny’s.

A collection appeal goes before an IRS officer settlement officer (or “SO,” in this context). In April, 2019 she sent a letter requesting a conference in May.

COMMENT: Notice the lapsed time – July, 2018 to April, 2019. Yep, it takes that long. It also explains while the IRS sent that CP90 (Notice of Intent to Levy): they know the process is going to take a while.

The taxpayers sent and the SO received a copy of their 2018 tax return. They showed wages of over $200,000.

OK, so they had cash flow.

All that personal financial information they had sent earlier showed cryptocurrency holdings of over $7 million. Heck, they were even drawing over $19,000 per month on the account.

More cash flow.

COMMENT: Folks, there are technical issues in this case, such as checking or not checking a certain box when requesting a collection hearing. I am a tax nerd, so I get it. However, all that is side noise. Just about anyone is going to look at you skeptically if you cite cash issues when you have $7 million in the bank.

The SO said no to the payment plan.

The Strashny’s petitioned the Tax Court.

COMMENT: Notice that this case does not deal with tax law. It deals, rather, with tax procedure. Procedure established by the IRS to deal with the day-to-day of tax administration. There is a very difficult standard that a taxpayer has to meet in cases like this: the taxpayer has to show that the IRS abused its authority.

The Strashny’s apparently thought that the IRS had to approve their request for a payment plan.

The Court made short work of the matter. It reasoned that the IRS has (with limited exceptions) the right to accept or reject a payment plan. To bring some predictability to the process, the IRS has published criteria for its decision process. For example, economic hardship, ill health, old age and so on are all fair considerations when reviewing a payment plan.

What is not fair consideration is a taxpayer’s refusal to liquidate an asset.

Mind you, we are not talking a house (you have to live somewhere) or a car (you have to get to work). There are criteria for those. We are talking about an investment portfolio worth over $7 million.

The Court agreed with the IRS SO.

So do I.

Was there middle ground? Yes, I think so. Perhaps the Strashny’s could have gotten 12 or 24 months, citing the market swings of cryptocurrency and their concern with initiating a downward price run. Perhaps there was margin on the account, so they had to be mindful of paying off debt as they liquidated positions. Maybe the portfolio was pledged on some other debt – such as business debt – and its rash liquidation would have triggered negative consequences. That approach would have, however, required common sense – and perhaps a drop of empathy for the person on the other side of the table – traits not immediately apparent here.

They got greedy. They got nothing.

Our case this time was Strashny v Commissioner.

Can You Have Reasonable Cause For Filing Late?

I am looking a reasonable cause case.

For the non-tax-nerds, the IRS can abate penalties for reasonable cause. The concept makes sense: real life is not a tidy classroom exercise. If you have followed me for a while, you know I strongly believe that the IRS has become unreasonable with allowing reasonable cause. I have had this very conversation with multiple IRS representatives, many of whom agree with me.

I am looking at one where the penalty was $450,959.

To put that in perspective, a January 29, 2019 MarketWatch article stated that the median 65-year-old American’s net worth is approximately $224,000.

Surely the IRS would not be assessing a penalty of that size without good reason – right?

Let’s go through the case.

Someone died. That someone was Agnes Skeba, and she passed away on June 10, 2013.

Agnes had an estate of approximately $14 million, the bulk of which was land (including farmland) and farm machinery. What the estate did not have was a lot of cash.

On March 6, 2014 the attorney sent an extension form and payment of $725,000 to the IRS.         

COMMENT: An estate return is due within 9 months of death, if the estate is large enough to require a return. Seems within 9 months to me.

The attorney included the following letter with the payment:

Our office is representing Stanley L. Skeba, Jr. as the Executor of the Estate of Agnes Skeba. Enclosed herewith is a completed “Form 4768 — Application for Extension of Time to File a Return and/or Pay U.S. Estate Taxes” along with estimated payment in the amount of $725,000 made payable to “The United States Treasury” for the above referenced Estate Tax.

Additionally, we are requesting a six (6) month extension of time to make full payment of the amount due. Despite the best efforts of this office and the Executor, the Estate had limited liquid assets at the time of the decedent’s death. Accordingly, we have been working to secure a mortgage on a substantial commercial property owned by the Estate in order to make timely payment of the balance of the Estate Tax anticipated to be due.

Currently, we have liquid assets in the amount of $1.475 million and the estimated value of the total estate is $14.7 million. Accordingly, we have submitted payments in the amount of $575,000 to the State of New Jersey, Division of Revenue, for State estate taxes payable and in the amount of $250,000 to the Pennsylvania Department of Revenue for State inheritance taxes payable. We are hereby submitting the balance of available funds to you, in the amount of $725,000, as partial payment of the expected U.S. Estate Taxes for the Estate.

We are in the process of securing a mortgage, which was supposed to close prior to the taxes being due, in the amount of $3.5 million that would have permitted us to make full payment of the taxes timely. Due to circumstances previously unknown and unavoidable by the Executor, the lender has not been able to comply with the closing deadline of March 7, 2014. It is anticipated that the lender will be clear to close within fourteen (14) days and then we will remit the balance of the estimated U.S. Estate Taxes payable.

Additionally, there has been delays in securing all of the necessary valuations and appraisals due to administrative delays caused by contested estate litigation currently pending in Middlesex County, New Jersey.

I would say he did a great job.

But the estate did not pay-in all of its estimated tax ….

A few days later the estate was able to refinance. The estate made a second payment of $2,745,000 on March 18, 2014. This brought total taxes paid the IRS to $3,470,000.

COMMENT: Mrs. Skeba died on June 10^th. Add 9 months and we get to March 10^th. OK, the second payment was a smidgeon late.

Now life intervened. It took a while to get the properties appraised. The executor had health issues severe enough to postpone the court proceedings several times. The estate’s attorney was diagnosed with cancer, delaying the case. Eventually the law firm replaced him as lead attorney altogether, which caused further delay.

As we said: life.

The estate asked for an extension for the federal estate tax return. The filing date was pushed out to September 10, 2014.

The estate was finally filed on or around June 30, 2015.

          COMMENT: Nine-plus months later.

The tax came in at $2,528,838, with estimated taxes of $3,470,000 paid-in. The estate had a refund of $941,162.

Until the IRS slapped a $450,959 penalty.

Huh?

The IRS calculated the penalty as follows: 

$2,528,838 – 725,000 = 1,803,838 times 25% = $450,959

The reason? Late filing said the IRS.

On first pass, it seems to me that the worst the IRS could do is assess penalties for 8 days (from March 10 to March 18). Generally speaking, penalties are calculated on tax due, meaning the IRS has to spot taxes you already paid-in.

In addition, need we mention that the estate was OVERPAID?

The attorney asked for abatement. Here is part of the request:

Beyond September 10, 2014, the Estate continued to have delays in filing due to the pending and anticipated completion of the litigation over the validity of the decedent’s Will, which would impact the Estate’s ability to complete the filing and the executor’s capacity to proceed. Initially, it, was anticipated that the trial of this matter would be heard before Judge Frank M. Ciuffani in the Superior Court of New Jersey in Middlesex County, Chancery Division-Probate Part in July of 2014. Due to health concerns on behalf of the Plaintiff, Joseph M. Skeba, the Judge delayed these proceedings multiple times through the end of 2014, each time giving us a new anticipation of the completion of the trial to permit the estate tax return to be filed. Upon the Plaintiffs improved health, the Judge finally scheduled a trial for July 7, 2015, which was expected to allow our completion in filing the return.

           

Accordingly, this litigation, which was causing us reason to delay in the filing, gave rise to the estate’s inability to file the return.

Finally, in May of 2015 we were notified of the Estate’s litigation attorney, Thomas Walsh of the law firm of Hoagland Longo Moran Dunst & Doukas, LLP, that he was diagnosed with cancer that would possibly cause him to delay this matter from proceeding as scheduled. In early June, we were notified by Mr. Walsh’s office that his prognosis had worsened and he would be prevented from further handling the litigation of this matter, so new counsel within his firm would be assisting in carrying this matter through trial. Due to the change in counsel, it was deemed that the anticipated trial was no longer predictable in scheduling, so the Estate chose to file the return as it stood at such time.

Displaying the compassion and goodwill toward man of deceased General Soleimani, on or around November 5, 2015 the IRS responded to the attorney’s letter and stated that the reasons in the letter did not “establish reasonable cause or show due diligence.”

Shheeeessshh.

The accountant got involved next. He included an additional reason for penalty abatement:

I do not believe the IRS had knowledge of the extension in place at the time the penalty was assessed, nor did they have a record of the additional payment of $2,745,000. The IRS listed the unpaid tax as $1,803,838 and charged the maximum 25% to arrive at the penalty of $450,959.50. The estate not only paid the entire tax the estate owed by the due date to pay but also had an overpayment. Section 6651(b) bars a penalty for late filing when estimated taxes are paid.

           

The IRS did not respond to the accountant.

The accountant tried again.

Here is the Court:

                To date, IRS Appeals has not responded to either letter.

I know the feeling, brother.

You know this is going to Court. It has to.

The estate’s argument was two-fold:

1.  The estate was fully paid-in. In fact, it was more than fully paid-in.
2.  There was reasonable cause: an illiquid estate, health issues with the executor, issues with obtaining appraisals, an estate attorney diagnosed with cancer, on and on.

The IRS came in with hyper-technical wordsmithing.

Based on § 6151, the Government cleverly reasons that the last day for payment was nine months after the death of Agnes Skeba—March 10, 2014; because no return was filed by that date a penalty may be assessed. Applying the rationale to the facts, the Government contends only $750,000 was paid on or before March 10, 2014, when $2,528,838 was due on that date. Referring back to § 6651(a)(1), a 25% penalty on the difference may therefore be assessed because it was not paid by March 10, 2014. As such, the full payment of the estate tax on March 18, 2014 is of no avail because the “last date fixed” was March 10, 2014. Accordingly, the Government argues that the imposition of a penalty in the amount of $450,959.00 is appropriate.

The Court brought out its razor:

The Government puts forth a valid point that there is an administrative need to complete and close tax matters. Here, the Estate had nine months to file the return, the extension added six months, and Defendant unilaterally added another nine months to file the return. Although there was the timely payment of the estate taxes, the matter, in the Government’s view, lingered and the administrative objective to timely close the file was not met. See generally Boyle, 469 U.S. at 251. There may be a need for some other penalty for failure to timely file a return, but Congress must enact same.

Slam on the wordsmithing.

COMMENT: Boyle is the club the IRS trots out every time there is a penalty and a late return. The premise behind Boyle is that even an idiot can Google when a return is due. The IRS repetitively denies penalty abatement requests – with a straight face, mind you – snorting that there is no reasonable cause for failure to rise to the level of a common idiot.

That said: did the estate have reasonable cause?

Finally, another issue in this case is whether Plaintiff demonstrated reasonable cause and not willful neglect in allegedly failing to timely file its estate tax return. Although the Court has already determined that the penalty at issue was not properly imposed pursuant to the Government’s flawed statutory rationale, it will review this issue for completeness.

In the tax world, folks, that is drawing blood.

In this case, Mr. White submitted his August 17, 2015 letter explaining the rationale for not filing. (See supra at pp. 5-6). For example, in Mr. White’s letter, he indicated that certain estate litigation was delayed due to health conditions suffered by the executor. (Id.). Additionally, Mr. White refers to the Hoagland law firm and one of the attorneys assigned to the case as having been diagnosed with cancer. (Id.). The Hoagland firm is a very prestigious and professional firm and based on same, Mr. White’s letter shows a reasonable cause for delay.

In addition, Mr. White’s prior letter of March 6, 2014 notes that there was difficulty in “securing all of the necessary valuations and appraisals. . . caused by the contested litigation.” (Hayes Cert., Ex. C). Drawing from my professional experience, such appraisals often require months to prepare because a farm located in Monroe, New Jersey will often sit in residential, retail, and manufacturing zones. To appraise such a farm requires extensive knowledge of zoning considerations. Thus, this also constitutes a reasonable cause for delay.

I hope this represents some whittling away of the Boyle case. That said, I wonder whether the IRS will appeal – so it can protect that Boyle case.

I would say the Court had little patience with the IRS clogging up the pipes with what ten-out-of-ten people with common sense would see as reasonable cause.

Our case this time for the home gamers was Estate of Agnes R. Skeba vs U.S..

Repaying The Health Care Subsidy

Twice in a couple of weeks I have heard:

“They should check on the Exchange.”

The Exchange refers to the health insurance marketplace.

In both cases we were discussing someone who is between jobs.         

The idea, of course, is to get the subsidy … as someone is unemployed and can use it.

There might also be a tax trap here.

When you apply for Obamacare, you provide an estimate of your income for the coverage year. The answer is intuitive if you are applying for 2020 (as we are not in 2020 yet), but it could also happen if you go in during the coverage year. Say you are laid-off in July. You know your income through July, and you are guessing what it might be for the rest of the year.

So what?

There is a big what.

Receive a subsidy and you have to pay it back – every penny of it – if your income exceeds 400% of the poverty line for your state.

Accountants refer to this as a “cliff.” Get to that last dollar of income and your marginal tax rate goes stratospheric.

Four times the poverty rate for a single person in Kentucky is approximately $50 grand.  Have your income come in at $50 grand and a dollar and you have to repay the entire subsidy.

It can hurt.

How much latitude does a tax preparer have?

Not much. I suppose if we are close we might talk about making a deductible IRA contribution, or selling stock at a loss, or ….

There may be more latitude if one is self-employed. Perhaps one could double-down on the depreciation, or recount the inventory, or ….

Massoud and Ziba Fanaieyan got themselves into this predicament.

The Fanaieyans lived in California. He was retired and owned several rental properties. She worked as a hairstylist.

They received over $15,000 in subsidies for their 2015 tax year.

Four times the California poverty line was $97,000.

They reported adjusted gross income of $100,767.

And there was (what I consider) a fatal preparation mistake. They failed to include Form 8962, which is the tax form that reconciles the subsidy received to the subsidy to which one was actually entitled based on income reported on the tax return.

The IRS sent a letter asking for the Form 8962.

The Fanaieyans realized their mistake.

Folks, for the most part tax planning is not a retroactive exercise. Their hands were tied.

Except ….

Mr. Fanaieyan remembered that book he was writing. All right, it was his sister’s book, but he was involved too. He had paid some expenses in 2012 and 2013. Oh, and he had advanced his sister $1,500 in 2015.

He had given up the dream of publishing in 2015. Surely, he could now write-off those expenses. No point carrying them any longer. The dream was gone.

They amended their 2015 tax return for a book publishing loss.

The IRS looked at them like they had three eyes each.

To Court they went.

There were technical issues that we will not dive into. For example, as a cash-basis taxpayer, didn’t they have to deduct those expenses back in 2012 and 2013? And was it really a business, or did they have a (dreaded) hobby loss? Was it even a loss, or were they making a gift to his sister?

The Court bounced the deduction. They had several grounds to do so, and so they did.

The Fanaieyans had income over four times the poverty level.

They had to repay the advance subsidies.

I cannot help but wonder how this would have turned out if they had claimed the same loss on their originally-filed return AND included a properly-completed Form 8962.  

Failing to include the 8962 meant that someone was going to look at the file.

Amending the return also meant that someone was going to look at the file.

Too many looks.

NCAA: From Cream Cheese To Endorsements

You may have read that the NCAA voted to allow students to benefit financially from the use of their name, image or likeness.

In truth, their hand was forced when California Governor Newsom signed the Fair Pay to Play Act on Lebron’s television show “The Shop.” Other states, including Florida, were also lining up on the issue.

Newsom was striking at an organization that realized over a $1 billion in revenues last year from “student-athletes,” all the while banning players from receiving any compensation other than scholarships.

Mind you, this is the same organization that used to ban schools from serving bagels with cream cheese. The NCAA argued (with a straight face somehow) that a bagel was a snack but a bagel with cream cheese was a meal. Meals were a no-go.

The tax hook for this post came from North Carolina (U.S.) Senator Richard Burr, who indicated he would introduce a bill to tax scholarships if the student-athlete also earns money from endorsements.

Methinks that Senator Burr is not a fan of the new rule.

Alternatively, he may subscribe to the new-economics theory of taxing something until it stops doing whatever triggered its taxation in the first place.

Did you know that some scholarships are already taxable?

Yep, the plain-old variety.

Scholarships used to be tax-free until 1980. The Code was then changed to look at whether services were being performed as a requirement for receiving the scholarship. Teaching assistantships would now be taxable, for example.

There was further change in 1986, when the Code began taxing scholarships used for living expenses.  If one received a scholarship, it was now important to determine whether it was for tuition or for room-and-board. Tuition was tax-free but room-and-board was not.

COMMENT: This change seems erratic to me, considering that The College Board has reported that living expenses make-up over half the cost of undergraduate education.

Scholarships for non-degree students next became taxable.

I would have to think about what national existential peril we barely avoided with that change to the tax law.

Senator Burr would add another exception-to-the-exception if you could buy a jersey with someone’s name on it. Alabama’s Tua Tagovailoa comes to mind. Your being able to buy a jersey with his name and number would make his scholarship taxable. It probably means little in Tua’s case, as he is projected to be a first round NFL draft selection. Take someone in a less prominent sport and the result might not feel as comfortable.

Then again, someone less prominent would probably not get into a payment-for-name, image-or-likeness situation.

A Rant On IRS Penalties

I am reading that the number one most-litigated tax issue is the accuracy-related penalty, and it has been so for the last four years.

The issue starts off innocently enough:

You may qualify for relief from penalties if you made an effort to comply with the requirements of the law, but were unable to meet your tax obligations, due to circumstances beyond your control.

I see three immediate points:

(1)  You were unable to file, file correctly, pay, or pay in full

(2)  You did legitimately try

(3)  And it was all beyond your control

That last one has become problematic, as the IRS has come to think that all the tremolos of the universe are under your control.

One of the ways to abate a penalty is to present reasonable cause. Here is the IRS:

Reasonable cause is based on all the facts and circumstances in your situation. The IRS will consider any reason which establishes that you used all ordinary business care and prudence to meet your federal tax obligations but were nevertheless unable to do so.

How about some examples?

·       Death

Something less … permanent, please.

·       Advice from the IRS

·       Advice from a tax advisor

That second one is not what you might think. Let’s say that I am your tax advisor. We decide to extend your tax return, as we are waiting for additional information. We however fail to do so. It got overlooked, or maybe someone mistakenly thought it had already been filed. Whatever. You trusted us, and we let you down.

There is a Supreme Court case called Boyle. It separated tax responsibilities between those that are substantive/technical (and reasonable cause is possible) and those which are administrative/magisterial (and reasonable cause is not). Having taken a wrong first step, the Court then goes on to reason that the administrative/magisterial tasks were not likely candidates for reasonable cause. Why? Because the taxpayer could have done a little research and realized that something – an extension, for example - was required. That level of responsibility cannot be delegated. The fact that the taxpayer paid a professional to take care of it was beside the point.

So you go to a dentist who uses the wrong technique to repair your broken tooth. Had you spent a little time on YouTube, you would have found a video from the UK College of Dentistry that discussed your exact procedure. Do you think this invites a Boyle-level distinction?

Of course not. You went to a dentist so that you did not have to go to dental school. You go to a tax CPA so that do not have to obtain a degree, sit for the exam and then spend years learning the ropes.      

·     

• Fire, casualty, natural disaster or other disturbances
• Inability to obtain records
• Serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family

I am noticing something here: you are not in control of your life. Some outside force acted upon you, and like a Kansas song you were just dust in the wind.

How about this one: you forgot, you flubbed, you missed departure time at the dock of the bay? Forgive you for being human.

This gets us to back to those initially innocuous string of words:

          … due to circumstances beyond your control.”

When one does what I do, one might be unimpressed with what the IRS considers to be under your control.

Let me give you an example of a penalty appeal I have in right now. I will tweak the details, but the gist is there.

·   You changed jobs in 2015 

·   You had a 401(k) loan when you left

·   Nobody told you that you had to repay that loan within 60 days or it would be considered a taxable distribution to you. 

·   You received and reviewed your 2015 year-end plan statement. Sure enough, it still showed the loan.  

·   You got quarterly statements in 2016. They also continued to show the loan. 

·    Ditto for quarter one, 2017. 

·   The plan then changed third-party administrators. The new TPA noticed what happened, removed the loan and sent a 1099 to the IRS.

o   Mind you, this is a 1099 sent in 2017 for 2015.

o   To make it worse, the TPA did not send you a 1099.     

•  The IRS computers whirl and sent you a notice.
•  You sent it to me. You amended. You paid tax and interest.
•  The IRS now wants a belt-tightening accuracy-related penalty because ….

Granted, I am a taxpayer-oriented practitioner, but I see reasonable cause here. Should you have known the tax consequence when you changed jobs in 2015? I disagree. You are a normal person. As a normal you are not in thrall to the government to review, understand and recall every iota of regulatory nonsense they rain down like confetti at the end of a Super Bowl. Granted, you might have known, as the 401(k)-loan tax trap is somewhat well-known, but that is not the same as saying that you are expected to know.  

I know, but you never received a 1099 to give me. We never discussed it, the same as we never discussed Tigris-Euphrates basin pottery. Why would we?

Not everything you and I do daily comes out with WWE-synchronized choreography. It happens. Welcome to adulthood. I recently had IRS Covington send me someone else’s tax information. I left two messages and one fax for the responsible IRS employee – you know, in case she wanted the information back and process the file correctly – and all I have heard since is crickets. Is that reasonable? How dare the IRS hold you to a standard they themselves cannot meet?

I have several penalty appeals in to the IRS, so I guess I am one of those practitioners clogging up the system. I have gotten to the point that I am drafting my initial penalty abatement requests with an eye towards appeal, as the IRS has  convinced me that they will not allow reasonable cause on first pass - no matter what, unless you are willing to die or be permanently injured. 

I have practiced long enough that I remember when the IRS was more reasonable on such matters. But that was before political misadventures and the resulting Congressional budget muzzle. The IRS then seemed to view penalties as a relief valve on its budget pressures. Automatically assess. Tie up a tax advisor’s time. Implement a penalty review software package in the name of uniformity, but that package's name is “No.” The IRS has become an addict.

When The IRS Does Not Believe You Filed An Extension

I have a certain amount of concern whenever we approach a major due date. Let’s use your personal tax return as an example. It is due on April 15; an extension stretches that out to October 15. 

What is the big deal?

Penalties. Fail to extend the return, for example.

How does this happen?

A client moves to another city. A client was unhappy with your fees last year, and you are uncertain if the client is staying with you. A client’s kid starts working, prompting a tax return for the first time. A client gets involved with some business, and the first time you hear about it is when his/her information comes in. A client does business in a new state.

Or – let’s be frank here – you just miss it.

There are two common penalties; think of them as the salt and pepper of penalties:

·      Failure to file

·      Failure to pay

We associate the IRS with taking our money, so one would easily assume that the more onerous penalty is failure to pay. It is not. Owe money past April 15 and the IRS will charge a penalty of ½% per month.

Fail to file, however, and the penalty is 5% per month.

Yep, 10 times as much.

And when does the penalty start?

Miss that extension and it starts April 16.

Huh? Don’t you have until October 15 to file that thing?

Yes, IF you file an extension.

You do not want to miss that extension.

I was reading a case about the Laidlaw brothers. They sold Harley Davidson motorcycles, and they got pulled into Court for a welfare benefit plan that went awry.

There was one issue left: did their accountant file extensions for the two brothers by April 15? If not, those penalties included 5 zeroes. We are talking enough-to-buy-a-house money.

To add to the stress, the trial occurred about a decade after the tax year in question.

The accountant’s name was Morgan, and he presented extensions showing zero tax due for each brother. The IRS said it never received any extensions. Morgan did not send the extensions certified mail, but he recalled sending both extensions in the same envelope. He remembered taking the envelope to the post office and checking for proper postage. He took pride that the Post Office had never returned an extension request for insufficient postage.

He pointed out that there was no question about an extension for the year before, and the year before that, and so forth. The brothers were significant clients to his firm, and he went the extra mile.

The IRS was having none of it. They pointed out that Morgan had many clients, and the likelihood that he could remember something that specific from a decade ago was dubious. Additionally, any memory was suspect as self-serving.

Sounds like Morgan needed to present well in front of the Court.

And there is the rub. The Laidlaw case went Rule 122, meaning that depositions were submitted to the Court, but there was no opportunity for face-to-face questioning.

Here is the Court:

… we had no opportunity to observe Mr. Morgan’s credibility as a witness. The reliability of a witness’ testimony hinges on his credibility. We were not provided a full opportunity – so critical to our being able to find the witness reliable – to evaluate Mr. Morgan’s credibility on the issue of timely filing because petitioners never offered his live testimony in a trial setting. While we can learn much from reading the testimony, it is not the same as a firsthand observation of the witness’ demeanor and sincerity, both essential aspects of credibility and reliability.

The brothers lost, and the IRS collected a sizeable penalty amount.

Back in the day, we used to log all extensions going to the IRS. We would certify each envelope and then attach the receipt to a log detailing each envelope’s contents. Granted, that log could not prove that a given envelope contained a given extension, but it did show our attention to policies and procedures. I recall getting out of at least one sizeable penalty by arguing that point to the IRS.

Those were different times, and many (including me) would say that today’s IRS is less forgiving of basic human error

And, to some extent, we are talking ancient history with extension procedure. Today’s practices, our included, has moved to electronic filing. Our software tracks and records our extensions and returns and their receipt by the IRS. I do not need to keep a mail log as my software does it for me.

Morgan needed something like a log. It would have given the Court confidence in and support for his recollection of acts occurring a decade earlier, even without him being present to testify in person.

You Got Repossessed And The Bank Says You Have HOW MUCH Income?

I ran into a cancellation-of-debt issue recently.

You may know that – should the bank or finance company cancel or agree to reduce your debt – you will receive a Form 1099. The tax Code considers forgiveness of debt to be taxable income, as your “wealth” has increased - supposedly by an amount equal to the debt forgiven. There are exceptions to recognizing income if you are insolvent, file for bankruptcy and several other situations.

Let me give you a situation here at galactic headquarters:

Married couple. Husband is a doctor. Husband buys a boat. He puts both the boat and the promissory note in the wife’s name, presumably in case something happens and he gets sued. They divorce. It is understood that he will keep the boat and make the bank payment. He does not. The boat is repossessed and then sold for nickels on the dollar. Wife (who was never taken off the note) receives a Form 1099-C. She has cancellation-of-debt income, which is bad enough. To make it worse, income is inflated as the bank appears to have sold the boat at a fire-sale price.

Our client is – of course – the wife.

The person who signs on the note receives the 1099 and reports any cancellation-of-debt income. If the debt “belongs” to your spouse and not to you, you better have your name removed from the debt before you get out of divorce court. The IRS argues that – if you receive a 1099 that “belongs” to your ex-spouse - you should seek restitution by repetitioning the court. This makes it a divorce and not a tax issue. The IRS is not interested in a divorce issue.

It all sounds fine until real life.

The wife received a $100,000-plus Form 1099-C from that boat.

Let’s reflect on how she there:

(1)  The wife doesn’t have a boat and never did. Hubby wanted a boat. She signed on the note to keep hubby happy.

(2)  The wife’s divorce attorney forgot to get that note out of her name. Alternatively, the attorney could have seen to it that wife also wound up with the boat.

(3)  For whatever reason, husband let the boat be repossessed.

(4)  The bank issued a Form 1099-C to the wife. The income amount was simple math: the debt less whatever the bank received for the boat.

Let’s introduce real life:

• What if the bank makes a mistake?
• What if the bank virtually gives the boat away?

The IRS has traditionally been quite inflexible when it comes to these 1099s. If the bank reports a number, the IRS will run with it.

You can see the recipe for tragedy.

Fortunately, the IRS pressed too far with the 2009 Martin case.

In 1999 Martin bought a Toyota 4-Runner. He financed over $12 thousand, but stopped making payments when the loan amount was about $6,700. The Toyota was repossessed. He received a Form 1099-C for the $6,700.

… which meant that the bank received zero … zip… zilch… on the sale of the 4-Runner.

Doesn’t make sense, does it?

The IRS did not care. Go back to the lender and have them change the 1099, they said.

COMMENT: Sure. I am certain the lender will jump right on this.

Martin did care. He told the Court that the Toyota was worth roughly what he owed on it when repossessed, and that the 1099-C was incorrect.

Enter Code section 6201(d):

(d) Required reasonable verification of information returns In any court proceeding, if a taxpayer asserts a reasonable dispute with respect to any item of income reported on an information return filed with the Secretary under subpart B or C of part III of subchapter A of chapter 61 by a third party and the taxpayer has fully cooperated with the Secretary (including providing, within a reasonable period of time, access to and inspection of all witnesses, information, and documents within the control of the taxpayer as reasonably requested by the Secretary), the Secretary shall have the burden of producing reasonable and probative information concerning such deficiency in addition to such information return. 

Normally, the IRS has the advantage in a tax controversy and the taxpayer has the burden of proof. 

Code section 6201(d) provides that – if you can assert a reasonable dispute with respect to an item of income reported on an information return (such as a 1099-C), you can shift the burden of proof back to the IRS.

The Tax Court decided that Martin had shifted the burden of proof. The 4-Runner had to be worth something. The ball was back in the IRS’ court.

Granted, Martin was low-hanging fruit, as the bank reported no proceeds. The IRS should have known better than to take this case to court, but they did and we now have a way to challenge an erroneous 1099-C.  

In our wife’s case, I am thinking of getting a soft appraisal on the value of the boat when repossessed. If it is materially different from the bank’s calculation (which I expect), I am considering a Section 6201(d) challenge.

Why? Because my client should not have to report excess income if the bank gave the boat away. That was a bank decision, not hers. She had every reasonable expectation that the bank would demand and receive fair market value upon sale. Their failure to do so should not be my client’s problem. 

Which will be like poking the IRS bear.

But she has received a questionable $100,000-plus Form 1099-C. That bear is already chasing her.