Paying Personal Expenses Through A Business

I am looking at a tax case.

It reminds me of something.

There is a too-common belief that paying an expense through a business can somehow transmute an otherwise personal expenditure into a tax deduction.

Here are common ways I have heard the question:

(1)  My spouse is going to replace her car. Should we buy it through the business?

(2)  I run my business from my home. That makes my home a “headquarters,” right? Can’t I deduct all the expenses related to my business headquarters?

(3)  I am going to borrow money to [go on vacation/pay college tuition/buy a boat I’ve been wanting]. Should I have the business borrow the money to make it deductible?

Do not misunderstand, many times there is a more tax-efficient way to accomplish something. There may still be some tax though, and the goal is to minimize the tax. Making it disappear may not be an option, at least for a responsible practitioner.

Let’s look at the above questions.

(1) Realistically, if there is no business use of the vehicle, you are not allowed to deduct any of the ownership or operating expenses of a vehicle. Despite that, does it happen routinely? Of course. Practitioners do what they can, but it is like fighting the tide.

(2)  I consider this quackery, but it is a true story. No, working from home does not make your house fully deductible. You might get a home office deduction out of it, but that is a fraction of some – and not all – expenses. No, your house is not Proctor and Gamble. Get over it.

(3) This one might have traction, but in general the answer is no. Even if the interest is deductible, how is the company getting you the money? Is it going to lend it to you? If so, you will have to pay interest to the company, although you may be able to arbitrage the rate. Will the company bonus you the money? If so, I see FICA and income taxes in your future. Explain to me the win condition here.

Let’s look at Justin Maderia (JM).

JM lived in Florida and owned 50% of Lindy Inc (Lindy).

Lindy must be a C corporation, which is the type that pays its own taxes. I say this because the Court refers to earnings and profits (E&P), which is a C corporation concept. The purpose of E&P is to track a corporation’s ability to pay dividends. When it pays dividends, a corporation is sharing its accumulated profits with its shareholders. The corporation has already paid taxes on these profits (remember: a C corporation pays taxes). When it pays dividends, you are personally taxed on that previously taxed profit. This is the reason for “qualified dividends” in the tax Code: to cut you a break on that second round of taxation.

The IRS was looking at JM’s 2018 personal return. It was also looking at Lindy’s 2018 business return.

COMMENT: It is not unusual to include a closely held company with the audit of an individual tax return.

The IRS wanted to increase JM’s 2018 income by $192 grand of “stuff” that Lindy paid on his behalf.

COMMENT:  Sounds to me like Lindy was paying for EVERYTHING.

Let’s talk procedure here.

The IRS identified personal transactions in Lindy. Lindy was the type of corporation that could pay dividends, and the IRS argument was – to the extent Lindy paid for personal stuff – that such payments represented constructive dividends to JM.

Fair. Consider that the serve.

JM gets to return.

He would argue that the payments were not personal because … well, who knows why.

JM did nothing.

Huh?

JM did nothing because he had a previous audit, and the IRS never pursued the issue of Lindy payments. JM believed he was immunized.

Mind you, there is a kernel of truth here, but JM has googled the concept beyond all recognition.

IF the IRS looks at an issue AND makes no change to your tax return for that issue, you can challenge a later proposed assessment based on that same issue. You might not win, mind you, but you have grounds for the challenge.

Is this what happened to JM?

Let’s look at it.

The IRS examined his prior year return.

Score one for JM.

The IRS never looked at Lindy.

We are done.

There is no immunity. JM cannot challenge a proposed 2018 assessment on an issue the IRS did not examine in a prior year.

JM had to return on different grounds. He did not. He - procedurally speaking - automatically lost.

JM had $192 grand of additional income.

The IRS next wanted the accuracy-related penalty.

Well, of course they did. If they were any more predictable, we could just put it on a calendar.

The Court said “no” to the penalty.

Why?

Because the IRS had looked at JM’s previous return. The IRS either did not bring up or dismissed the Lindy issue, so JM kept reporting the same way. While this would not protect him from a challenge of additional income, it did provide a “reasonable basis” defense against penalties.

Our case this time was Maderia v Commissioner, T.C. Summary 2024-5.

IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

An IRS Payment Plan And Tax Evasion

 

Let’s talk today about IRS payment plans. More specifically, let’s talk about common paperwork in requesting a payment plan.

A common one is Form 433-A, and it is used by W-2 workers and self-employeds.

The IRS is trying to figure out how much you earn, own, and owe.

There are questions about whether you (or your spouse) own a business, are a beneficiary of a trust or have gifted property worth more than $10,000 over the last 10 years. Yes, they wanna know stuff.

You will have to list your bank accounts, as well as other investments, real estate and other assets.

You will have to provide an accounting of your monthly income and expenses.

There is also expanded disclosure if you are self-employed (that is, a sole proprietor).

There are other ways to own a business than as a proprietor (for example, a shareholder in a C corporation). The IRS will want to know about that, too.

Part of tax practice is avoiding this series, if possible. For example, if you have personal tax debt of $50,000 or less, you can bypass the 433 series and request a “streamlined” payment plan. You are still entering into a contract with the IRS (you must stay current with your filings, make all payments as required, and so on), but in exchange the IRS lifts some of the paperwork requirements. Sometimes advisors recommend hybrid arrangements (taking out a second mortgage, for example), leaving the IRS debt at $50 grand or less. And sometimes you are simply into the IRS for more than $50 grand, leaving no choice but to run the 433 gauntlet. This can be a rude awakening, as the IRS uses standards for certain expense categories (for example, housing and utilities). You might google that you can request an increase from these standards. You can request; don’t expect to receive, though. Barring significant factors (think care for chronic medical conditions), it is unlikely to happen. Depending on the numbers, you might be forced to downgrade a vehicle or pull the kids from a private school. This is not a friendly loan.  

And you do not want to be … sly … when running the 433 hurdles.

Let’s look at someone who was too clever by half.

Kevin Crandell is a medical doctor. He contracted with two hospitals, one in Mississippi and another in Alabama, for $30 to $40 grand per month.

From 2006 through 2012 he did not file returns or pay taxes.

The IRS started garnishing his wages in 2010.

COMMENT: I find it remarkable that he still did not file or pay even when garnished.

The doctor racked up close to a million dollars in taxes, penalties, and interest.

Somewhere in there he formed a couple of corporations. He used one to receive monies earned as a contractor. The second appeared to serve as asset protection.

He finally hired someone (Blue Tax) to help out with tax returns and attendant debt.

Blue Tax drafted a 433. The first draft showed Crandell’s salary as $17 grand per month (I don’t know where the rest of the money went either). The doctor howled that the number was much too high and should be closer to $12 grand.

Oh, the 433 also left out bank accounts for those two corporations (which he controlled). And a $50,000 gun collection. And the $40 grand he drew from the corporations shortly after submitting a 433 stating that his salary was around $12 grand.

Doc, you have to know when to stop. Lying, and then lying about the lying is called something in tax.

Crandell was indicted for fraud.

That pattern of non-file and non-pay looked bad now. That “creative” 433 also gleamed like a badge of fraud, leaving off income, assets and so on.

Crandell argued that he relied on Blue Tax.

It is a good argument - an excellent argument, in fact - except that he did not fully disclose to Blue Tax. If you want to show reliance on an advisor, you have to … you know … actually rely on the advisor.

Crandell was convicted for tax evasion.

Our case this time was US v Crandell, 2023 PTC 178 (5^th Cir. 2023).

Choose The Lesser Of IRS Grumpiness

 

Let’s talk about the failure to file (FTF) penalty.

Most of us must file an annual income tax return. Unless one is an expat (that is, an American living overseas), the return is due April 15. One can extend the return for six months (that is, until October 15), but the extension is for filing paperwork and not for payment of tax.

How is one supposed to estimate the tax if a significant amount of information is unavailable? Many times, there are estimates or informed guesses; the tax preparer will extend the return using those. Sometimes there are no estimates and no informed guesses; one then does their best. I doubt there isn’t a veteran tax preparer that hasn’t been blindsided by a Schedule K-1.

Let’s continue.

You extend your return. Your K-1 comes in heavier than expected. You owe $5,000 in tax with the return, which you file and pay on October 15.

You will have something called the Failure to Pay (FTP) penalty. The tax nerds know this as the Section 6651(a)(2) penalty. The penalty is as follows:

One-half of 1% for each month or part of a month

To a maximum of 25%

Let’s use our $5,000 example.

I count seven months from April through October (remember: a part of a month counts as a month).

The FTP penalty would be $5,000 times .005 times 7 = $175. It stings, but it is not crushing.

Let’s say the return was filed on October 30.

Has something changed?

Yep.

The IRS is strict about filing deadlines. If the return is extended to October 15, then you have until October 15 to file the return (or at least put it in the mail or submit the electronic file). The 15th is not a suggestion.

What happens if you miss the deadline?

You then filed your return late.

Back to our example. You file the return on October 30. You are just 15 days late. How bad can 15 days be?

It is not intuitive. If you file the return on October 30, you have blown the extension, meaning it is like you never submitted an extension at all. Any penalty calculation starts on April 16.

So what? The FTP penalty is still the same: $5,000 times .005 times 7, right?

The difference is that you have just provoked FTP’s big brother: the Failure to File (FTF) penalty. The FTF is the gym-visiting, MMA-training, creatine supplementing and aggressive sibling to the FTP.

Start with the FTP penalty. Multiply it by 10. The tax nerds know the FTF as the Section 6651(a)(1) penalty. 

Are we saying the FTF penalty is $5,000 times .05 times 7?

Nope, this is tax. There is a loop-the-loop to the FTF calculation.

• The maximum (a)(1) and (a)(2) penalty is 5% per month or part of a month.
• The math stops when you get to 25% in total.

The first loop means that the FTP penalty comes in at .005 and the FTF penalty comes in at .045 per month (or part thereof), as the maximum cannot exceed .050 per month.

The second loop means that the math stops when you get to 25%.

How does a tax pro handle this?

Easy: multiply by 25%.

Let’s go back to the math: $5,000 times 25% = $1,250.

This could have stopped at $175 had you just filed the return on October 15. Nah, you thought to yourself. What’s another couple of weeks?

$1,075, that’s what ($1,250 - $175). That is an expensive two weeks.

So, what got me fired up about this topic?

I saw the following on a tax return this past week:

Go to the bottom where it reads “Interest Penalties.” Go across to “Failure to File.” You will see $3,619.

Someone has just thrown away over three-and-a half grand by dragging their feet on filing. There goes a vacation, new electronics for the house, an IRA contribution - anything better than sending it to the government.

The client has two years of this, BTW.

But CTG, you say, maybe they did not have the money to pay.

The FTF does not mean that one is unable to pay. Granted, in real life the two issues often go together. One rationalizes. I do not have any money; if I delay filing maybe I can also delay IRS dunning letters and collection activity.

Maybe, but practice tells me it is rarely worth it. You have to go over four years with an FTP penalty before you equal just five months of FTF penalty. That money is just too expensive.

Let’s go back to our example.

Say the $5,000 is for tax year 2021. The taxpayer filed the return on or before October 15, 2022 and only now can pay the tax. What have we got?

First, the FTF penalty goes away, as the return was filed on time.

Second, the FTP penalty would be: $5,000 times .005 times 16 = $400. (I am running the penalty from April 2022 to July 2023)

Third, there will be interest, of course, but let’s ignore that for now.

$400 versus $1,075. Seems clear to me.

What can be done if one cannot get numbers together by October 15?

Here’s a thought.

I have a client who owns a successful drywalling company. We extended his return several years ago, and sure enough – closing in on October 15 – he was out-of-town, relaxed and unconcerned about any looming doom. However, I knew that he had a good year, and that any tax due was going to be significant. An FTF penalty on significant tax due was also going to be significant. We decided to file his return with the best numbers available, intending to amend whenever we obtained more precise numbers.

Did I like doing that?

That is a No.

Did he avoid the FTF?

That is a Yes, but he delayed getting us more accurate numbers. That delay created its own problems. Problems which were … completely … avoidable.

What is our takeaway?

File your return. Extend if you must, but file by the extension date. File even if you cannot pay. Yes, the IRS will penalize you. The IRS is grumpy about not getting its money. The IRS is grumpier, however, about not getting the tax return in the first place.

Remember: when given the option, choose the lesser of IRS grumpiness.

A 1099 Reporting Rule Is Delayed

 

You may have heard that the IRS recently delayed a 1099 reporting rule that was going to otherwise affect a lot of people this filing season.

We are talking about payments apps such as Venmo, PayPal, Square and Cash App. Use Lyft or Uber, purchase something on Etsy or buy lunch at a food truck and you are likely paying cash or using one of these payment platforms.

For years and years, the tax rules require a payment processor to issue a 1099 to a business if two things happened:

(1)  The business received payments exceeding $20,000 and

(2)  There were more than 200 transactions.

This flavor of 1099 is a “1099-K.” It basically means that one received payment for a business transaction by accepting a credit card or mobile payment app. Mind you, this is not the same flavor of 1099 as those for interest or dividend income, rent or stock sales. A 1099-K is issued to a business, not to an individual. However, an individual having a business – think a side gig – can receive a 1099-K for that gig. Think Uber or Etsy – or a teenage babysitter – and you get the distinction.  

I remember when the $20,000/200 rule came in. There was one year when the IRS wanted taxpayers to separate business revenues on their tax return between those reported on a 1099 and those not. Clients were not amused with locating and providing those 1099 forms. Preparers quickly adjusted by reporting all revenues as reported on a 1099, despite IRS protestations that it would render their computer matching superfluous. True, but preparers cannot spend a lifetime preparing one tax return because Congress and the IRS want a DNA match on any economic activity during the year.   

Congress changed the $20,000/200 law. The American Rescue Plan of 2021 reduced the dollar threshold to $600 in the aggregate, with no threshold on the number of transactions.

Fortunately, some of the business apps are trying to minimize the damage. PayPal and Venmo, for example, are allowing users to distinguish whether a payment is personal - think a birthday gift – or a payment for goods and services. Personal payments do not require 1099-K reporting.   

Many tax professionals were concerned how this expanded reporting would mesh with an IRS that is just barely getting itself off the floor from COVID202020212022. The IRS still has unprocessed tax returns and correspondence to wade through – the same IRS that recently destroyed millions of tax documents because they relinquished hope of ever processing them.

The 1099-K reporting has not gone away completely, though. The IRS delayed the $600 rule, but the old rule - $20,000 and 200 transactions – is still in effect. Yeah, it can be confusing.

Have you wondered why that $600 limit has never changed? The $600 has been around since the Internal Revenue Code of 1954, and prior to 1954 there was comparable reporting for certain payments exceeding $1,000. Mind you, average annual U.S. income in 1954 was less than $4,000. You could buy a house for twice that amount.  

Had that $600 been pegged for inflation – not an unreasonable request to make of Congress, which caused the inflation - it would be almost $6,700 today.

And Congress would not be burdening everybody with 1099 reporting at dollar thresholds less than you spend monthly on groceries.

 

The Problem-Child Client: Recidivist

 

It happens: the problem-child client.

Let’s talk about one type of problem child: the recidivist.

Thomas Kelly was a securities broker in New York City. We have three tax years at play - 2013 to 2015. Thomas had not been filing his returns or paying his taxes.

On December 22, 2017, he filed 2013, reporting adjusted gross income of $1.9 million. The tax was approximately $690 grand.

A few days later (December 26, 2017) he filed 2014, reporting AGI of almost $1.5 million and tax of approximately $515 grand.

Keeping the streak going, on January 17, 2018, he filed 2015, reporting AGI of $1.2 million and tax over $400 grand.

Got it. Thomas fell out of the system and was now trying to get back in. Maybe there had been familial or medical setbacks. He was trying to correct his mistakes. Everybody likes a comeback story.

Let’s jump forward over a year and a half to September 2019. Thomas owed the IRS over $2.5 million for years 2013 through 2015.

Late file penalties. Late pay penalties. Interest on everything. Yep, it gets expensive.

The IRS issued three notices:

* Two for liens

* Another for a levy

Thomas requested a CDP (Collection Due Process) hearing. He was after three things:

* He wanted a payment plan

* He wanted withdrawal of the liens

* He wanted abatement of the penalties

Got it. So far this is standard stuff.

The hearing was scheduled for March 2020.

Then COVID happened.

The hearing was held-up until February 2021.

At the hearing …

FIRST, Thomas wanted to pay $30,000 per month.

Problem: Thomas owed enough that $30 grand would not pay his taxes in full before the statute of limitations played out.

CTG: This is a called a partial pay plan. There are requirements in the Internal Revenue Manual (IRM), and one is that the taxpayer be current on his/her other taxes. Thomas owed approximately $250 grand on his 2019 taxes.

The IRS did not want to include 2019 in his payment plan. In addition, the IRS did not see payments on his 2020 estimated taxes.

CTG: Borrow $250 grand and a bit more for those estimated taxes, Thomas. Battle, war, and all that.

It makes sense if you think about it. Thomas was asking the IRS to accept less than a dollar-on-a-dollar for past taxes. He was then asking the same deal for his current taxes. The IRS was not going to agree to this.

Thomas dug in his heels and wanted the IRS to include 2019 and 2020 in the payment plan.

The IRS of course didn’t.

Thomas complained that the IRS settlement officer abused his discretion in denying him a payment plan.

CTG: Thomas, shut up.

SECOND, Thomas wanted the liens removed.

CTG: This one is going to be tricky. The IRS is reluctant to remove a lien, especially once you get to those dollar levels.

Thomas argued that the IRS Settlement Officer abused his discretion in refusing to withdraw the liens.

CTG: Thomas … SHUT UP!

Thomas next argued that releasing the lien would facilitate his being able to pay the tax. The lien would affect his licensing, and that effect could negatively impact his earning power.

CTG: Nice segue. We now need to go from “could” to “would,” as we need to persuade skeptical parties. Is there a cite from governing body rules and regulations we can copy and paste? Can you get a letter from your employer? We need something more than our word, as that is considered self-serving.

Nope, says Thomas. My word is good enough.

CTG: You are not taking advice well, Thomas.

THIRD, Thomas wanted the penalties abated. He had two arguments.

CTG: Bring it.

The first was that he qualified for first time abatement (FTA).

CTG: OK, but that will address 2013 only. You won’t be able to use it again for the other years.

FTA is bread-and-butter. If you have been clean for the preceding 3 years, the IRS can waive the penalty. The FTA applies to a limited number of penalties, but the good news is that limited number included Thomas’s specific penalty.

Good job, Thomas.

However, the IRS pointed out that Thomas had penalties for 2012. The … tax … year … immediately … preceding 2013.

CTG: Thomas, did you even google what FTA is?

Thomas had a second argument: he had reasonable cause.

CTG: OK, Thomas, sway me.

His wife started spending money like madwoman in 2007. This caused all matters of marital and financial problems. She filed for divorce in 2015.

CTG: Thomas …

The attorney fees were crushing. He was having financial hardship …

CTG: Thomas …

… emotional problems …

CTG: Thomas …

… battling depression.

CTG: Thomas, the Court is going to want to know how your divorce proceedings – in 2015 – affected your tax responsibilities for 2013 and 2014.

Tax Court: Yes, Thomas, please tell us.

Here are a few trenchant comments by the Court:

He successfully conducted his securities business during 2013 – 2015, earning more than $1 million annually …”

… he has a history of tax noncompliance, dating as far back as 2009.”

His allegations of financial hardship at the relevant times thus seem questionable.”

CTG: We are losing them here, Thomas.

Tax Court:

In any event, financial hardship ‘generally does not affect a person’s ability to file.’”

CTG: Going…

Tax Court:

At the time of the CDP hearing petitioner’s outstanding liabilities for 2013 - 2015 exceeded $2.5 million. Those liabilities arose from his repeated failure to file returns and pay tax, despite earning between $1 million and $2 million annually. During the hearing he refused to pay even his (comparatively modest) estimated tax liability for 2020.

CTG: Gone.

Yes, the IRS sours with a recidivist. I have seen the IRS dig in when they see someone failing to file, never paying estimates, extending with no payment, repetitively filing returns with significant balances due. This is not a matter of knowing how to navigate the IRS. One can navigate like Magellan and not get there.

Thomas could have - I believe - gotten a partial pay. Perhaps he needed to borrow to pay 2019 and 2020, but: so what? He had the earning power, and borrowing would have facilitated the (much more significant) $2.5 million at play for 2013 through 2015.

He had a shot at releasing the liens if he could show (likely) injury to his earning power. He had to show some cause, though, otherwise everyone would make this argument and the IRS would never be able to lien.   

He was hosed on penalty abatement, however. Recidivist.

He certainly did not need to fling charges of abusing discretion. The Settlement Officer was just following IRM guidelines, which Thomas (or his tax advisor) could have double-checked at any time.   

Our case this time was Thomas E Kelly v Commissioner, T.C. Memo 2022-73.

The IRS Caught Dumping A Collection Case

Let’s look at a taxpayer win on an issue not known for taxpayer wins.

Thomas Hamilton was an attorney and Edith Hamilton was a chaplain. They filed a 2016 tax return showing tax due of almost $72 thousand. They however did not pay the tax in full.

The IRS assessed.

The IRS then issued a Notice of Federal Tax Lien (NFTL) to secure its assessment.

This presented a procedural option: the Hamiltons could request a Collection Due Process (CDP) hearing. If they could work-out a payment agreement perhaps they might avoid the lien. Liens can be embarrassing.

They requested a CDP hearing.  

The IRS Settlement Officer (SO) asked for a lot of information, including:

(1)  Proof of 2018 estimated tax payments

(2)  Their 2017 personal tax return

(3)  Six months of bank statements

(4)  Three months of pay stubs

(5)  Proof of various expenses for the preceding three months

The SO also wanted the law practice to catch-up on its (mostly payroll-related) tax returns from 2015 through 2017.

The SO did stagger some of the due dates for the above: some were due on October 17, others were due October 24. The hearing itself was November 15, 2018.

The Hamiltons did not provide any documents by October 24.

Oh oh.

They did write a letter on October 31, explaining that their (now) previous bookkeeper failed to keep many documents, a fact which came to light as they were trying to comply with the SO’s request. They hired a CPA, who was helping reconstruct records as well as representing them during the CDP hearing. Finally, they had reordered online bank statements and would forward the requested documentation as soon as possible. They reiterated their desire for a payment plan.

Let me retract the “oh oh” comment, although they should have responded – in some manner - by the October 17 date.

Why? To discourage the SO from thinking that they were stalling.  

Between November 2 and November 15, the Hamiltons sent five faxes totaling hundreds of pages. They sent bank statements, copies of bills and some (but not all) of the payroll tax returns for the law practice.

The day before the hearing they also faxed personal and business financial information (Forms 433-A and 433-B) as well as a copy of their 2017 individual tax return and its electronic acceptance by the IRS.

The SO had spent no time on the case from October 1 to the date of the hearing, when she spent an hour preparing beforehand.

At the hearing the SO pressed on the following:

·      They had not filed their 2017 individual tax return.

·      They had not provided proof of their expenses.

·      They were not making 2018 estimated tax payments.

·      They had not filed payroll returns for the law practice.   

The CPA chimed in:

·      They had filed their 2017 tax return and provided proof of electronic acceptance by the IRS.

·      They had provided bank statements and documentation for the vast majority of their expenses.

·      They would be current with their 2018 estimated taxes as soon as the following month.

·      They had file some of the payroll returns the SO was considering unfiled.

The SO said she would recommend filing the NFTL.

Mr Hamilton requested additional time to provide the missing information.

The SO said: no chance.

The IRS sustained the filing of the NFTL for 2016 and also rejected their request for an installment agreement.

Sheesshh. That CDP hearing blew up.

And so we get to Tax Court.

Let’s set up the issue:

·      There was a proposed lien

·      To which taxpayers requested a CDP hearing

·      And got turned down for not complying with the SO’s documentation requests

You can take one of these to Tax Court, but it is very tough to win. In short, you must show that the IRS was capricious and abused its discretion. 

The Court went through the file:

1. The Hamiltons sent an 11-page fax on November 9. The fax included one of the payroll tax returns the SO considered missing.

    The SO had included the fax cover sheet in her record.

    But not the other 10 pages.

    One wonders how accurate the SO’s records were.

    Human error, one supposes.

2. They had filed their 2017 individual tax return and had faxed the SO a copy. They had also informed her of this filing at the hearing.

    But the SO had included the non-filing as a reason for her bounce.

    Odd.

3. Between November 2 and the November 15 hearing date, they had sent at least five faxes, totaling hundreds of pages of financial documentation

    But the SO said they had not provided documentation.

    Here is the Court:

The failure of the administrative record to capture some documents makes us question the completeness of the administrative record that the settlement officer considered and that we are reviewing.

    And here the case turned.

    The third strike.

The Court pointed out that the Hamiltons made efforts to keep the SO apprised – of the bookkeeper debacle, of the request for copies of documents and bank statements. They asked the SO to apprise them of any questions or issues while they could still react.

Then the Court emphasized that the SO had not even looked at the file until the day of the hearing.

The hearing where she nonetheless chastised the Hamiltons for not having provided all the paperwork.

Here is the Court:

She did not take them up on that offer; her doing so would have allowed the Hamiltons to address any issues before the November 15, 2018 hearing.”

The Court continued:

… the settlement officer made up her mind after a cursory one-hour review of the Hamiltons’ materials and failed to give proper consideration to the issues they raised …”

The cumulative effect of the settlement officer’s conduct in this case was to deprive the Hamiltons of fair consideration of their issues and concerns. The Hamilton’s conduct was by no means perfect, but it reflected consistent cooperation and good-faith effort throughout the CDP process.”

The SO’s decision was found arbitrary and lacking sound basis in fact or law.

The case was returned to IRS Appeals for another hearing.

The SO had gotten the case off her desk.

But she had not done her job.

And there you have a rare taxpayer win in the CDP arena.

Our case this time was Hamilton v Commissioner, T.C. Memo 2022-21.