Part Time Bookkeeper, Big Time Penalty

 

We filed another petition with the Tax Court this week.

For a client new to the firm.

Much of this unfortunately was ICDIM: I can do it myself. The client did not understand how the IRS matches information. There was an oddball one-off transaction, resulting in nonstandard tax reporting. Stir in some you-do-not-know-what-you-do-not-know (YDNKWYDNK), some COVIDIRS202020212022 and now I am involved.

I am looking at case that just screams YDNKWYDNK.

Here is part of the first paragraph:

This case is before the Court on a Petition for review of a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330, dated February 13, 2018 (notice of determination). The notice of determination sustained a notice of federal tax lien (NFTL) filing (NFTL filing) with respect to trust fund recovery penalties (TFRPs) under section 6672. The TFRPs were assessed against petitioner for failing to collect and pay over employment taxes owed by Urgent Care Center, Inc. (Urgent Care), for taxable quarters ending June 30 and September 30, 2014 (periods at issue), resulting in outstanding liabilities of $6, 184.23 and $4, 190.77, respectively.

That section 6330 is hard procedural, and it is going to hurt.

Mr Kazmi was a bookkeeper. He worked part-time at Urgent Care. Urgent Care did not remit employment taxes for a stretch, and unfortunately that stretch included the period when Mr Kazmi was there.

We are talking the big boy penalty, otherwise known as the responsible person penalty. The point of the penalty is to migrate the tax due to someone who had enough authority and responsibility to have paid the IRS but chose not to.

Mr Kazmi had no ownership interest in Urgent Care. He was not an officer. He was not a signatory on any bank accounts. He had no authority to decide who got paid. At all times he worked under the authority of the person who owned the place (Dr Senno). What he did have was a tax power of attorney.

Folks, I probably have a thousand tax powers of attorney out there.

Sounds to me like Mr Kazmi was the least responsible person (at least for payroll taxes) at Urgent Care.

The IRS Revenue Officer (RO) thought otherwise and on December 16, 2015 issued Mr Kazmi a letter 1153, a letter which said “tag, you are a responsible party; have a nice day.”

From what I am reading, this was a preposterous position. I generally have respect for ROs, but this one is a bad apple.  

Still, there are consequences.

Procedurally Mr Kazmi had 60 days to challenge the 1153.

He did not.

Why?

He did not know what he did not know.

A little time passed and the IRS came for its money. It wanted a lien. It also wanted a vanilla waffle ice cream cone.

Mr Kazmi yelled: Halt! He filed for a Collection Due Process (CDP) hearing. In the paperwork he included the obvious:

I am just a part-time bookkeeper. I am not responsible for collection or accounting or making payments for any tax payments for Urgent Care.

Makes sense.

Doesn’t matter.

He did not know what he did not know.

Let’s talk about the “one bite at the apple” rule.  In the current context, the rule means that a taxpayer cannot challenge an underlying liability if he/she already had a prior opportunity to do so.

One bite.

Mr Kazmi had his one bite when he received his letter 1153. You remember – the one he blew off.

He was now in CDP wanting to challenge the penalty. He wanted a second bite.

Not going to get it.

CDP was happy to talk about a payment plan and deadbeat taxpayers and whatnot. What it wouldn’t do was talk about whether Mr Kazmi deserved the penalty chop to begin with.

I am not a fan of such hard procedural. The vast majority of us will go a lifetime having no interaction with the IRS, excepting perhaps a minor notice now and then. It seems unreasonable to hold an average someone to stringent and obscure rules, rules that most attorneys and CPAs – unless they are tax specialists – would themselves be unaware of.

Still, it is what it is.

Does Mr Kazmi have any options left?

I think so.

Maybe a request for reconsideration.

Odds? So-so, maybe less.

A liability offer in compromise?

I like that one better.

Folks, it would have been much easier to pop this balloon back when the IRS trotted out that inappropriate letter 1153.

Mr Kazmi did not know what he did not know.

Our case this time was Kazmi v Commissioner, T.C. Memo 2022-13.

  

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.

IRS Wants Near $9 Million Penalty From A Holocaust Survivor

 

I’ll tell you what caught my eye:

This is a tax case in which the Government alleges that Defendant Walter Schik, a Holocaust survivor, failed to file a foreign bank account reporting form with the Internal Revenue Service …, which now seeks by this action to collect an almost nine-million-dollar civil penalty assessed against him for that failure.”

There are so many things wrong with that sentence.

Let’s talk about Form TD F 90-22.1, also known as the FBAR (“Eff- Bar”). The form existed before I took my first course in accounting years ago, but it has gathered steam and interest when Treasury started to chase overseas bank accounts during the aughts. If one has a foreign account, or has authority over a foreign account, which exceeds $10,000 during the taxable year, one is required to disclose on one’s individual income tax return (on Schedule B) and file Form TD F 9-22.1 with the Treasury.

Up to this point, it is just another form to file. We are drowning in forms, so what is the big deal?

The deal is the penalties for not filing the form. Let’s separate not filing the form because you did not know you had to file from knowing you had to file but deciding not to. That second one is considered “willful” (which makes sense) and can cost you a penalty from $100,000 to 50% of the account balance at the time of violation.

This is VERY expensive money.

The IRS assessed a penalty of almost $9 million against Schik for failure to file an FBAR.

Some background:

·      Mr Schik is a Holocaust survivor.

·      His education was cut short by, how shall we say this …, being in a concentration camp.

·      After the war, he immigrated to the U.S. and became a citizen.

·      After becoming a citizen, he opened a Swiss bank account where he deposited monies recovered from relatives who were slaughtered during the Holocaust.

·      He left the monies in Switzerland as he was fearful that another Holocaust-like event could occur.

·      Schik did not touch or manage the money. That was done by his son and a Swiss money manager.

·      Schik did talk with the money manager occasionally, though.

·      By 2017 one of those Swiss accounts had over $15 million.

·      His accountant never asked Schik if he had overseas bank accounts or explained the recently heightened IRS interest in the area.

I am sympathetic with the accountant. What are the odds of having a client who is a Holocaust survivor and having over $15 million in a Swiss bank account? One could go a career. I have.

The year at issue is 2007. There is a question on the individual tax return whether one has an interest or signature authority over a foreign bank account. Schik’s accountant answered it “No.” Schik did not correct his accountant. More fairly, Schik did not even notice the question.

Wouldn’t you know that Schik’s Swiss money manager got pulled into the UBS investigation?

UBS entered into a deferred prosecution arrangement with the United States. It however had to provide identities of U.S. citizens and residents who were customers of the bank.

At which point Schik submitted a voluntary disclosure to the IRS.

Which the IRS denied.

Without an alternative, Schik submitted a late FBAR.

The IRS then slapped the 50% penalty we are talking about.

Which brings us up to speed.

The penalty requires one’s behavior to be “willful.” Not surprisingly, the word has specific meaning under the law, and the Court evaluated whether Schik’s behavior was willful.

Treasury argued that “willful” means “objectively reckless.”

Got it. Ignoring an issue to an extreme degree is the same as knowing and not caring.

Schik argued that willful means “intentional disregard.”

The difference?

Schik argued that the underlying law was opaque, long-ignored and now quickly – if somewhat capriciously – conscripted into action. He no more intentionally disregarded his tax reporting obligations than he intentionally disregarded the newest developments in cosmological galaxy formation. There was no conspiracy by hundred-year-old Holocaust survivors: he just didn’t know.

And such is tax law. Nine million dollars hangs on the meaning of a word.

The Court noted that other courts – relying on records similar to those available to it - have found willfulness.

Not good for Schik. 

However, the Court was concerned about the many countervailing factors:

·      Schik was nearly 100 years old.

·      Schik had minimal formal education.

·      Schik did not manage the money.

·      Schik did not prepare his own tax returns.

·      Schik had no idea about a disclosure requirement.

·      Schik’s accountant did not explain the disclosure requirement.

·      The question answered “No” was pre-filled by the accountant’s software and did not represent any assertion made by Schik.

The Court denied the IRS summary judgement, noting there was a substantial question of fact.

I agree.

Who will review and clarify the facts?

“The Court believes that the Parties in this case would benefit from mediation. By separate order the Court will refer the Parties to the Southern District of New York’s Mediation Program. … the assigned District Judge … may determine that a case is appropriate for mediation and may order that case to mediation, with or without the consent of the parties.”

Methinks the IRS should just have allowed the voluntary disclosure.  

Was the IRS encouraging compliance, promoting education and providing a ramp to enter/reenter the tax system? Or is this something else, something with the purpose of terrifying the next person?

Our case this time was United States of America v Walter Schik, 20-cv-02211 (MKV)

Not Filing A Return and Owing Tax

 

The question comes up periodically, even among accountants: 

Is there a penalty for filing a late return if the taxpayer has a refund?

In general, the answer is no. Mind you, this is not an excuse to skip filing. If anything, you have money due to you. Do not file for three years and you are losing that refund.

Let’s switch a variable:

Is there a penalty for filing a late return if the taxpayer owes taxes?

Uhhhh, yes.

As a rule of thumb, assume an automatic 25% penalty, and it can be more.

So what happens if someone cannot file by the extended due date?

I have a one of these clients. I called him recently to send me his 2020 information.

His comment?

         I thought you took care of it.”

Now, I have been at this a long time, but I cannot create someone’s return out of thin air. Contrast that with estimating a selected number or two on a tax return. That happens with some regularity, although - depending on the size and tax sensitivity of the numbers – I might flag the estimates to the IRS’ attention. It depends.

Let look at the Morris case.

James and Lori Morris were business owners in Illinois. In 2013 James expanded the business, creating a new company to house the same. They had a long-standing relationship with their CPA.

The IRS came in and looked at the 2013 return. It appears that there were issues with the start-up and expansion costs of the new business, but the case does not give us much detail on the matter.

The Morris’ held up filing a return for 2014. They also held up filing 2015 and 2016, supposedly from concern of repeating the issue the IRS was addressing on the 2013 return.

Seems heavy-handed to me.

Well, as long as they were fully paid-in:

They did not make any estimated tax payments during the year at issue and did not have tax withheld from their paychecks during 2015. Petitioner-husband had a minimal amount of tax withheld from his wages during 2016. Petitioner-wife had withholding credits of $10 and $11 during 2015 and 2016, respectively.”

Got it: next to nothing paid-in.

Maybe the businesses were losing money:

For 2015 and 2016 petitioners, respectively, had ordinary income from their S corporations of over $2.2 million and $3 million.”

What was going on here? I am seeing income over $5 million for two years with little more than $21 of tax paid-in.

The Morris’ argued that their long-standing CPA advised that filing a return while an audit for earlier years was happening could subject them to perjury charges.

COMMENT: Huh? There are areas all over the Code where a taxpayer and the IRS might disagree. If it comes to pass, one appeals within the IRS or files with a court. The system does not lock-down because the IRS disagrees with you.

Frankly, I am curious what was on that return that the issue of “perjury” even saw the light of day.

Oh, well. Let’s have the CPA testify. Hopefully the Morris’ will have reasonable cause for penalty abatement because of their reliance on a tax professional.

Mr Knobloch (that is, the CPA) did not testify at trial, and there is no evidence in the record except for petitioner-husband’s testimony of Mr. Knobloch’s alleged advice.”

The Court was not believing this for a moment. 

We need not accept a taxpayer’s testimony that is self-serving and uncorroborated by other evidence, and we do not do so here.”

I find myself wondering why the CPA did not testify, although I have suspicions.

I also do not understand why – even if there were substantive issues of tax law – the Morris’ did not pay-in more for 2015 and 2016.  Did they think they had losses? OK, they would be out the money for a time but they would get it back as a refund when they file the returns.

They instead racked-up big penalties.

Our case this time was Morris v Commissioner, T.C. Memo 2021-120.

Penalties, Boyle and “Reductio Ad Absurdum.”

 

In logic there is an argument referred to as “reductio ad absurdum.” Its classic presentation is to pursue an assertion or position until it – despite one progressing logically – results in an absurd conclusion. An example would be the argument that the more sleep one gets, the healthier one is. It does not take long to get to the conclusion that someone who sleeps 24 hours a day – in a coma, perhaps – is in peak physical condition.

I am looking at a tax case that fits this description.

What sets it up is our old nemesis – the Boyle decision. Boyle hired an attorney to take care of an estate tax return. The attorney unfortunately filed the return a few months late, and the IRS came with penalties a-flying. Boyle requested penalty abatement for reasonable cause. The Court asked for the grounds constituting reasonable cause. Boyle responded:

                  I hired an ATTORNEY.”

Personally, I agree with Boyle.

The Court however did not. The Court subdivided tax practice in a Camusian manner by holding that:

·      Tax advice can constitute reasonable cause, as the advice can be wrong;

·      Relying on someone to file an extension or return for you cannot constitute reasonable cause, as even a monkey or U.S. Representative could google and find out when the filing is due.

 Here is an exercise for the tax nerd.

(1)  Go to the internet.

(2)  Tell me when a regular vanilla C corporation tax return is due.

(3)  Change the corporate year-end to June 30.

a.    When is that return due?

Yes, the due dates are different. I know because of what I do. Would you have gone to step (3) if I had not pushed you?

Jeffery Lindsay was in prison from 2013 to 2015. He gave his attorney a power of attorney over everything – bank accounts, filing taxes and so on. Lindsay requested the attorney to file and pay his taxes. The attorney assured him he was taking care of it.

He was taking care of Lindsay, all right. He was busy embezzling hundreds of thousands of dollars is what he was doing. Lindsay got wind, sued and won over $700 grand in actual damages and $1 million in punitive damages.

The IRS came in. Why? Because the last thing that the attorney cared about was filing Lindsay’s taxes, paying estimates, any of that. It turns out that Lindsay had filed nothing for years. Lindsay of course owed back taxes. He owed interest on the tax, as he did not pay on time. What stung is that the IRS wanted over $425 grand in penalties.

He did what you or I would do: request that the penalties be abated.

The Court wanted to know the grounds constituting reasonable cause.

Are you kidding me?

Lindsay pointed out the obvious:

         I was in PRISON.”

Here is the Court:

One does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due.”

The Court agreed with the IRS and denied reasonable cause.

Lindsay was out hundreds of thousand of dollars in penalties.

I consider the decision the logical conclusion of Boyle. I also think it is a bad decision, and it encapsulates, highlights and magnifies the absurdity of Boyle using the logic of “reductio ad absurdum.”

Our case this time was Lindsay v United States, USDC No 4:19-CV-65.

Exceptions to Early Distribution Penalties

 

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

Something new, methought.

Better known as a “bench opinion.’

Nothing new, methinks.

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

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

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

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

(1)  Pay back a 401(k) loan

(2)  Medical expenses

(3)  Student loans

(4)  Mortgage and other household expenses

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

Alright, she will have income tax.

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

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

·      Total and permanent disability

·      Death of the account owner

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

·      Unreimbursed medical expenses (up to a point)

·      IRS levy

·      Reservist on active duty

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

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

Is there a similar rule for an IRA?

·      Withdrawals after attaining age 59 ½.

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

Who knows.

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

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

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

·      Dividends from an ESOP

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

·      Higher education expenses

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

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

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

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

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

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

Nope.

There is no exception for general hardship.

10% penalty.

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

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

Ms Wold requested abatement of the penalty for reasonable cause.

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

You know who doesn’t get reasonable cause?

An attorney.

Here is the Court:

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

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

Literacy And Tax Penalties

I am looking at a Tax Court case.

It does not break any new ground, but there is a twist I do not remember seeing before.

Michael Torres and Elizabeth Ruzendall founded an S corporation (Water Warehouse).

In 2016 Michael found himself in a bad way health-wise. Elizabeth was around, though, even though she was no longer an owner. She ran the company in Michael’s absence.

It must have been a sweet gig, as Water Warehouse issued her a $166,494 Form 1099 for 2016.

Here is the oddball fact: Michael could not read or write. He was sick for so long, however, that he had time to learn.

Good for him.

In 2017 he came across the Form 1099. He could now read.

In 2018 he filed civil suit against Elizabeth.

Both the company’s and Michael’s personal 2016 tax returns were due in 2017. That did not happen, and both returns were filed in 2018.

Remember that an S corporation normally does not pay its own taxes. Instead, the S income would be included on Michael’s personal return, and he would pay tax on the sum.

Michael amended the 2016 S corporation return to subtract the $166,494 paid Elizabeth. Amended returns take an explanation, and it appears that the word “theft” may have come up.

As the corporate income went down, Michael’s personal income would simultaneously go down. Michael was now expecting a refund for 2016.

The IRS told him to pound sand.

And off to Court they went.

Embezzlement or theft are maddening topics in the tax Code.

A key question was whether a theft even occurred. When Elizabeth was running the show in 2016, Michael told her to take “what she felt was her pay.”

Be fair: Elizabeth could easily argue that she had done that.

Except she testified to taking the funds without Michael’s authorization.

And then you have the hurdles of the tax law itself.

The Code says that a theft is deductible when discovered.

Matthew discovered the theft in 2017.

He amended the 2016 corporate and personal tax returns.

That were due in 2017.

But filed late in 2018.

When was the theft discovered?

That would be 2017.

It cannot go on a 2016 return. It could go on a 2017 return, though.

Michael struck out. He claimed the theft a year early.

COMMENT: Once tax year 2016 became an issue with the IRS, he should have filed a protective claim for 2017. The purpose of the claim would be to keep the 2017 tax year open if the theft deduction in 2016 went against him.

The IRS however marched on: it wanted penalties.

I get it: he failed to file those 2016 returns on time.

However, the penalty can be abated for reasonable cause.

The Court said the IRS had reached too far. Michael had been sick for an extended period of time. He hired a new accountant upon learning of the 2016 issues. He taught himself to read and write. e taught himself to read and writeHe could now review his own accounting records rather than having to rely on others.

 

It sounded reasonable to the Court.

To me too.

This is the first time I can remember somebody receiving penalty abatement citing illiteracy.

However, it is probably more correct to say that Michael received abatement for becoming literate. I would say the Court liked him.

Our case this time was Torres v Commissioner, T.C. Memo 2021-66.

You Have To Look At Your Return

I am looking at a case that covers relatively well-trod ground. It did however remind me of a client from around 20 years ago. I got a different result than the taxpayer did in this case, but I suspect part of the reason is the IRS becoming noticeably more overbearing with penalties over the last two decades.

Anna Walton is a psychologist. In 2014 the firm where she worked informed her that their interests had diverged. This of course is jargon for termination, and she transitioned to her own firm with multiple clients, including Brown University and the National Geographic Society.

 Having multiple clients meant that she received multiple Forms 1099 at the end of the year. It is a poor idea to blow these off, as the IRS uses the 1099s for computer matching of reported income. Report less income than the 1099s on file and you can anticipate an automated notice from the IRS.

Let’s roll to January, 2016 and Ms Walton was looking at her 2015 records. She e-mailed her accountant of approximately 20 years that the practice had approximately $525 grand in revenues. The accountant used that number to arrive at an estimated tax payment.

So far there is no big deal.

She later sent her tax stuff in. A staff accountant working at the firm noted that the 1099s she remitted only added-up to approximately $351 grand. Cross-referencing the $525 grand e-mail, the accountant asked whether Ms Walton had or was expecting other 1099s. She also asked about other stuff, such as contributions, tuition plans and whatnot going into the tax return.

COMMENT: In case you are wondering, it is quite unlikely that your accountant personally prepares your tax return. It is more likely that he/she hires someone to prepare your return, including questions, and then reviews the draft return once fully or mostly prepared. I for example prepare very few returns, but I review a ton. There are not enough hours in the day for me to work with as many returns as I do if I also had to prepare them.

Ms Walton responded to the accountant but blew-off the 1099 question.

The accountant asked again.

Ms Walton blew her off again.

I think you get the drift.

The accountant prepared the return with the information available. The IRS caught the underreporting of 1099 income. The IRS wanted tax. It also wanted penalties.

Ms Walton agreed to the tax, but she did not think she should owe penalties.

Off to Tax Court they went

Her argument was easy: she relied on her accountant.

Folks, there are prerequisites to the reliance argument. For example, one has to provide all necessary information to the accountant. Secondly, that reliance is moot if even the most cursory review of the return would alert the average person to errors on the return.

The Court was quite curious why Ms Walton did not inquire why the return showed approximately one-third less revenues than she herself had previously told the accountant.

I also suspect that the Court did not take kindly to Ms Walton repetitively blowing-off the staff accountant. The repeated questioning would have/should have alerted a reasonable person that more attention was required on the matter.

The Court decided that she did not have reasonable cause to abate the penalty.

I agree.

My client back in the antediluvian days?

He left $3.5 million off his return.

The IRS wanted tax and penalties.

I argued the penalties.

What was my argument?

The client reported so much income from so many sources that $3.5 million could reasonably have been overlooked on that year’s return.

I wish I had a personal tax return like that.

I got penalty abatement, by the way.

Our case this time was Walton v Commissioner, T.C. Memo 2021-40.

 

Do. Not. Do. This.

Here is the Court:

With respect to petitioner’s Federal income tax for 2013 and 2014, the Internal Revenue Service … determined deficiencies and accuracy-related penalties as follows:

Year  Deficiency Penalty

2013 $338,752    $67,750

2014 7,030,829   1,406,166

I cannot turn down at least skimming a Tax Court case with penalties well over $1.4 million.

Turns out our protagonist is an attorney. He more than dabbled in tax practice:

·      During law school, he took courses in tax law and participated in a tax clinic assisting low-income taxpayers

·      During school he was employed by Instant Tax Services (ITS) in Baltimore. ITS operated on a franchise basis, and he was the area manager for four storefronts. After graduation he served as general counsel for five years.

·      While serving as general counsel, he started acquiring storefronts on his own behalf. By 2013 he owned he owned franchises for 19 locations.

·      These stores were profitable. Aggregate profits exceeded $800 grand over the years 2008 through 2010.

You know, sometimes I wonder what swoon I was in to spend an entire career with a CPA firm. It appears that the money is in setting up and franchising seasonal tax preparation storefronts.

In 2012 ITS attracted the attention of the U.S. Department of Justice – and in a bad way. In 2013 a district court permanently enjoined ITS and its owner from having anything to do with preparing federal tax returns.

COMMENT: Ouch.

Our protagonist was good friends with the owner of ITS. So close, in fact, that Justice refused to allow him to take over the ITS tax preparation business.

COMMENT: Something about helping the ITS owner hide around $5 million.

A third party stepped up to take over the ITS business. This new person formed Great Tax LLC, and many of the ITS franchisees came on board.

Our protagonist was not to be denied, however. He bought the tax preparation software from ITS, put it in an entity called Refunds Plus, LLC (RP), and in turn leased the software to Great Tax LLC.

COMMENT: There is existing commercial tax preparation software, of varying levels of sophistication. We, for example, use software that allows for very complicated returns. It costs a fortune, by the way. There is other software that tones it down a bit, as perhaps the tax practice prepares few or no returns of great complexity. In any event, writing my own software seems a monumental waste of time and money, except for the following tell:

“using this software to process tax returns for GTX customers, most or all of whom expected refunds.”

Most or all?  Riiiigggghht. Perhaps it is just as well that I have stayed with a CPA firm for all these years.

Great Tax LLC paid our protagonist $100.95 for each return it processed and which claimed a refund.

COMMENT: Was a non-refund return free?

Our protagonist worked out an arrangement with Great Tax which allowed him to take money out of Great Tax’s bank account. He also opened a bank account for RP. He moved over $3 million from Great Tax during 2014.

However, he did not deposit the monies from Great Tax into the RP bank account.

So where did the money go?

Who knows.

Since this went to Court, we know that the IRS figured-out what was going on.

Our protagonist agreed that he owed the taxes, but he requested abatement of the penalties for reasonable cause.

He has my attention: what was his reasonable cause?

·      He was a cash-basis taxpayer.

And I like meatball sandwiches. Pray tell what that has to do with anything.

·      There was little to no cash activity in the RP business bank account.

Seriously? Was he aware that failure to deposit funds in its entity-related account is an indicia of fraud?

·      He relied on an attorney.

Reliance on a professional can provide reasonable cause. Tell me more.

·      She had been working as a full-time lawyer for about a year.

Not impressed.

·      She had acquired some of the former ITS franchises.

Had to be a story somewhere.

·      She had represented him when the IRS pressed in a separate action for abuse of the earned income credit.

We just learned where all those refund returns came from.

Let me get this right: his reasonable cause argument is that an attorney prepared his return?

·      No.

Who prepared the return?

·      An accountant.

Why then are we talking about an attorney?

·      She advised our protagonist that he was not required to report the $3 million as gross receipts for 2014.

Our protagonist in turn told the accountant the same thing?

·      Yep. He relied on an attorney.

If this is true, she may be in the running for the worst attorney of the decade.

And why would he – an experienced attorney with some tax background – listen to an attorney with limited experience?

·      The attorney and our protagonist were codefendants in a lawsuit alleging misappropriation of funds.

Yessir.

The Court requested documentary evidence that an attorney would advise that moving approximately $3 million to bank accounts of one’s choosing was not taxable income.

I’m in: I want to see those documents myself.

·      She supplied no evidence of letters, memos or e-mails – dated before those returns were filed – in which she advised petitioner about the reporting of RP’s gross receipts.”

Rain is wet. Nighttime is dark.

How did the Court decide this mess?

We did not find either’s testimony on that point credible. Petitioner’s testimony was self-serving, and [the attorney] did not strike the Court as an objective or candid witness.”

The Court did not believe a word.

Our protagonist owed the tax. He owed the penalties.

Frankly, I am surprised that the IRS did not go after fraud in this case. Perhaps the IRS was prioritizing its limited resources.

I would say our protagonist got off easy.

Folks, this is not tax practice. You know what it is.

Do. Not. Do. This.

Our case this time was Babu v Commissioner, TC Memo 2020-21.