Penalties For Cash Reporting Failures

 

It would be a vast understatement to say that the plucky Rebellion had software issues this busy season.

We saw (some of) it coming … given the merger and all. Short of Excel and Word, there was little overlap between our softwares - that is, our preparation software, research software, time reporting, invoicing and receipt, monitoring the accounting practice and whatnot.

We are still working through the shock.

And I see a Tax Cout decision issued about a week ago concerning software.

I can tell you before reading it how the Court will decide:

Software – unless involving matters exceeding the minds of mortal men – will not save one from penalties. If one purchases and installs software, one is under obligation to learn and master it.

My thoughts?

I am divided. An ordinary taxpayer does not – should not - need my services. Reach a certain point though, and a tax professional becomes as necessary as a primary physician or a dentist.

Still, the Code has become increasingly complex since I came out of school. The very computerization that has allowed professionals to streamline and systematize their work has simultaneously allowed the Congressional tax committees to draft and score increasing complex and near-unworkable changes to the Code. Far too many of these changes can potentially reach ordinary taxpayers. That taxpayer would probably not know that he/she wandered into a minefield. He/she would learn of it when the penalty notice arrived, however. The IRS (and too often the courts) presume that you have a graduate degree in taxation – ignorance of the law is no excuse and all that flourish. They do not care that you don’t.

Dealers Auto Auction of Southwest LLC (Dealers) was an Arizona company selling vehicles through auction houses. It frequently received cash in the ordinary conduct of its business. Not surprisingly, the cash from a sale would often exceed $10,000.

There is a Code section involved here:

          Section 6050I

(a)  Cash receipts of more than $10,000

Any person

(1)  Who is engaged in a trade or business, and

(2)  Who in the course of such trade or business, receives more than $10,000 in cash in 1 transaction (or 2 or more related transactions),

shall make the return described in subsection (b) with respect to such transaction (or related transactions) at such time as the Secretary may by Regulations prescribe.

Once Sec 6050I is triggered, the company files Form 8300 with the IRS. It is an information return (no taxes go with it), but there are penalties for failure to file the return.

Not surprisingly, it has its own rules and subrules.

You know the Forms 8300 were an issue for Dealers.

They bought software (AuctionMaster) to deal with it.

They bought the software after flubbing the 2014 Form 8300 filings. The IRS assessed penalties of over $21 grand, and Dealers realized that buying software was cheaper than paying penalties.

And … the IRS was back in 2016.

Why?

Dealers filed 116 Forms 8300. The IRS argued that Dealers should have filed 382.

The IRS wanted over $118 grand in penalties.

Yipes!

Here is the Court:

Dealers Auto was not immediately aware of its failures. Instead, it was not until the Commissioner began the examination that Dealers Auto became aware of its noncompliance.”

Dealers was blindsided.

It took immediate steps:

·       It contacted the software provider and learned that improved aggregation features were available starting in 2017 (the year following the audit year).

·       Dealers quizzed the auditor on the subtleties of Form 8300 and its filing requirements.

·       Dealers changed its procedures and internal control for filing 8300s.

·       Dealers changed to electronic filing of the 8300s. They let the software cook.

No way the IRS was going to retract that $118 grand-plus assessment, though.

Dealers appealed the penalty. It wanted abatement for reasonable cause.

COMMENT: So would I, frankly.

Dealers’ argument was straightforward: we relied on software, and the software malfunction was outside of our control.

The IRS responded: there was no malfunction. You never mastered the software. If you had, you would have realized that it was not functioning as you thought.

Harsh, methinks. Probably honest, though.

Here is the Court:

Dealers Auto failed to establish that there was a software failure.”

The instructions for the software suggest that the software prepared Forms 8300 for printing, but Dealers Auto asserts that the software files the forms on the user’s behalf.”

Even assuming Dealers Auto met its burden to show a failure beyond the filer’s control, the record does not support a finding that Dealers Auto acted reasonably before or after the failure. For example, Dealers Auto did not establish that it was correctly using the software or that data was being entered correctly into the system.”

Dealers Auto argues that it reasonably believed the software was working as intended because it was generating some information returns. But the record shows that Dealers Auto software prepared only 116 Forms 8300 in 2016. The record also shows that Dealers Auto was required to file at least 212 Forms 8300 in 2014.”

This is going poorly.

What do I see?

I see a small business that was surprised in 2014. It responded with technology, but its familiarity with technology appears limited. It got surprised again. Normally that would indicate recidivism, but I don’t think that is what happened here. I think Dealers had only so many resources to throw at a problem. In addition, they may not have realized the extent of the problem if they were quizzing the IRS auditor on the ins and outs.

What did the Court see?

While it is not necessary to show that Dealers Auto made every data entry correctly, the record offers the Court no insight as to Dealer Auto’s installation, training, or use of the software.”

Here it comes:

Dealers Auto failed to establish that it has reasonable cause for its failure to file information returns for 2016.”

What disappoints me about cases like this is the failure to reward a taxpayer’s effort. Dealers tried. It bought software. It was filing, albeit not as much as it was supposed to. Should it have expended more money and resources on the matter? Clearly, but then I should have played in the NFL and retired as a Hall of Famer. The IRS is punishing Dealers like a scofflaw who did not care, made things up and never intended to follow the rules. To me, applying the same penalties to both situations is abusive.

Our case this time was Dealers Auto Auction of Southwest LLC v Commissioner, T.C. Memo 2025-38.

A Job, A Gig and Work Expenses

 

The case is straightforward enough, but it reminded me how variations of the story repeat in practice.

Take someone who has a W-2, preferably a sizeable W-2.

Take a gig (that is, self-employment activity).

Assign every expense you can think of to that gig and use the resulting loss to offset the W-2.

Our story this time involves a senior database engineer with PIMCO. In 2015 he reported approximately $176,000 in salary and $10,000 in self-employment gig income.  He reported the following expenses against the gig income:

·      Auto      $14,079

·      Other     $12,000

·      Office    $ 7,043

·      Travel    $ 6,550

·      Meals     $ 3,770

There were other expenses, but you get the idea. There were enough that the gig resulted in a $40 thousand loss.

I have two immediate reactions:

(1)  What expense comes in at a smooth $12,000?

(2)  Whatever the gig is, stop it! This thing is a loser.

In case you were curious, yes, the IRS is looking for this fact pattern: a sizeable (enough) W-2 and a sizeable (enough) gig loss.

In general, what one is trying to do is assign every possible expense to the gig. Say that one is financial analyst. There may be dues, education, subscriptions, licenses, travel and whatnot associated with the W-2 job. It would not be an issue if the employer paid or reimbursed for the expenses, but let’s say the employer does not. It would be tempting to gig as an analyst, bring in a few thousand dollars and deduct everything against the gig income.

It’s not correct, however. Let’s say that the analyst has a $95K W-2 and gigs in the same field for $5k. I see deducting 5% of his/her expenses against the gig income; there is next-to-no argument for deducting 100% of them.

The IRS flagged our protagonist, and the matter went to Court.

We quickly learned that the $10 grand of gig income came from his employer.

COMMENT: Not good. One cannot be an employee and an independent contractor with the same company at the same time. It might work if one started as a contractor and then got hired on, but the two should not exist simultaneously.

Then we learn that his schedule of expenses does not seem to correlate to much of anything: a calendar, a bank account, the new season release of Stranger Things.

The Court tells us that his “Travel” is mostly his commute to his W-2 job with PIMCO.

You cannot (with very limited exception) deduct a commute.

There were some “Professional Fees” that were legit.

But the Court bounced everything else.

I would say he got off well enough, all things considered. Please remember that you are signing that tax return to “the best of (your) knowledge and belief.”    

Our case this time was Pilyavsky v Commissioner.

A Tiger, Tax And Magic

There is an accounting firm in St. Louis that seems determined to remain highlighted in the professional literature, and not in a good way. In 2008 the federal government sued Zerjav & Company P.C.  (Zerjav) to permanently ban it from the tax business. There are two Zerjav’s in the firm: the father “Frank” and the son “Tiger.” The father is the CPA. Tiger’s co-workers have called him “the magician” because the numbers on tax returns employees prepare are “magically” different after he reviews the return. I have known people like Tiger. One is soon headed to jail for tax fraud.

The IRS must have gotten way ahead of itself with Zerjav, however, requesting but being denied a preliminary injunction. The government then reached a settlement in 2010 rather than prosecuting the case. Each side can claim victory in a settlement, of course, and the terms of this settlement were not especially harsh. Tiger was prohibited from preparing tax returns or giving tax advice for three years. His father was barred from certain conduct, including:

• claiming business deductions for personal expenses
• improperly deducting restaurant meals, child care or education expenses
• claiming wage deductions for children, unless the children actually worked and the wages were reasonable
• changing accounting records without informing the client

That is, the father was barred from doing things that CPAs are not allowed to do in the first place! The father manufactured deductions virtually out of thin air, but it must not have risen to the level of fraud. As a consequence, the father was permitted to continue his tax practice, although with oversight for a five-year period. 

Tiger could not prepare returns for a few years – but his father could. Really? One doesn’t have to be Houdini to figure an escape from that box.

Well, Tiger is back in the news. 

Last month the government filed an indictment alleging the following:

• Tiger and his wife filed a fraudulent 2001 return showing taxable income of $43,124,whereas the correct income was $210,268
• Tiger and his wife filed a fraudulent 2002 return showing taxable income of $14,053,whereas the correct income was $225,449
• Tiger and his wife filed a fraudulent 2003 return showing taxable income of $23,627,whereas the correct income was $158,984
• Tiger and his wife filed a fraudulent 2004 return showing taxable income of $149,415,whereas the correct income was $231,804

How did Tiger accomplish this sleight of hand? In each case, the government alleges that he altered QuickBooks to conceal his correct taxable income. The IRS issued its QuickBooks summons in 2011. Zerjav resisted but a District Court determined that Zerjav had to produce its electronic QuickBooks backup file.

Folks, this is fraud, and it will get one into HUGE problems with the IRS. Fraud brings in the Criminal Investigation Division of the IRS. These are the guys/gals who have badges and carry guns, and they have little to nothing to do with regular civil tax matters. If convicted, Tiger faces up to five years imprisonment and a $250,000 fine on each count.

Seems like Tiger’s magic may have run out.

New Jersey and the Telecommuter

We are visiting state taxation today. Our trip this time will take us to New Jersey, and it will highlight how tax law can simultaneously arrive at a technically correct but bumble-headed conclusion.

Let’s say you manufacture parts in New Jersey. Would you expect to file and pay state income tax to New Jersey?

That one is easy - of course. You are doing business there – in the meaningful sense of the phrase. You have a building, you have employees. You park your car out front. You visit Chipotle for lunch. You are there.

Let’s make this more challenging. You do not manufacture parts. You do not manufacture anything. You develop software. Your offices are in Rockville, Maryland. You do not have offices in New Jersey. You do not park your car in New Jersey or visit their Chipotle for lunch. You are not there. You have an employee who moves to New Jersey. You like her. You keep her on board.

Like a Jim Croce song, you have a name.  Your name is Telebright.

Let’s have her work from her new home. She begins her workday at 9:00 a.m. by checking with her project manager, who is based in Boston. She receives daily work assignments. When done, she uploads her work and sends it to you. She is expected to work 40 hours a week. She could live on the moon, for what location matters to her work.

She does not solicit customers. She does not have sales responsibility. She does not refresh products, or stock shelves, or install, or service. She does not supervise employees. She does not have management authority. You do not even reimburse for her office-in-home. She travels twice a year to Maryland. By the way, you do not pay for the travel – rather she pays for those trips out of her own pocket.

You – being enlightened – take New Jersey withholding taxes out of her paycheck so that she has no rude April 15^th surprise.

New Jersey surfaces, somewhat like the mutant alligator in a bad Sci-Fi network movie. New Jersey says that you are doing business in the state, and it wants you to … (wait on it) … pay corporate income taxes!

The case goes before the New Jersey Tax Court. The court cites the New Jersey statute:

Every domestic or foreign corporation which is not hereafter exempted shall pay an annual franchise tax for each tax year, as hereafter provided … for the privilege of doing business , [or] employing or owning capital or property … in this state.”

The Court then reflects philosophically:

The term ‘doing business’ is used in a comprehensive sense and includes all activities which occupy the time or labor of men for profit.”

It rolls up its sleeves and grittily reviews the law (N.J.A.C. 18:7-1.9(b)):

Whether a foreign corporation is doing business in New Jersey is determined by the factors in each case. Consideration is given to such factors as:

(4) The employment in New Jersey of agents, officers and employees.”

Oh, oh. This is going to go wrong, isn’t it? Or is it possible the court will recognize that a lone employee in the state hardly amounts to a corporate beachhead?  Here is the Court:

There is no one, single controlling factor nor is there a bright line standard that determines whether a foreign corporation’s in-state activities meet the Director’s regulatory requirements for doing business. Rather, it is only by close scrutiny of all the facts of the case, taken as a whole, that a final determination can be made. ”

It then digs in like a free agent seeking a new sports contract and drives for the bright line.

It cannot be disputed that plaintiff satisfies factor 4 … by employing Ms. … in New Jersey.”

[Telebright] agreed to permit Ms. … regularly to perform her duties at her New Jersey home.”

This consistent contact with New Jersey was not sporadic, occasional or intermittent.”

But the Court pauses. Will it realize that you are being a good sport for even keeping her employed after the move? Will it acknowledge that this is not a 19^th century economy, when a county seat could not be more than a day’s travel for any resident of the county? It hesitates:

“While it is true that [Telebright] has never maintained an office in New Jersey, nor solicited business here ….”

No! Not now Tax Court of New Jersey! You are so close!

The Court shakes it off:

 … [its] daily contact with the State through its employee is sufficient to trigger application of the CBT Act.”

The mere fact that Ms. … is the only … employee in this State does not change the court’s decision.”

Yes, the court determined that Telebright was responsible for New Jersey corporate tax because it permitted an employee to work from her home in New Jersey.

Why does this upset me?

One reason is that reasoning like this would have me filing taxes with India if I hired an on-line bookkeeper there.

Another reason is that I have read court decisions like this for more than two decades now. After a while it is like watching WWE wrestling – there really isn’t much suspense about who is going to win. There was a time when a state at least tried to develop coherent doctrines and workable principles. In recent years however state tax has become more like a hijacking on a Sopranos episode.

Another reason is this is an employee-hostile decision.

I have a friend and client, for example, who lives in Kentucky and commutes to California. Yes, you read that right. He works a week here in Kentucky and a week near San Francisco. He is situated well enough at the company that he floated the idea of having an “office” here. The company turned him down. Why? Because they do not have a footprint in Kentucky and his “office” could create one. So he commutes every other week to California. I suspect he may be their only Kentucky-resident employee.

If you were Telebright, what would you do? Would you not permit your employee to work from home, never mind the reasons? Would you even keep her as an employee?

Who gains here? Tony … er, Trenton gets a few dollars from its next mark … er, taxpayer. Who loses? For now, the company loses. In the future, the loser will be the next employee who wants to work from a New Jersey residence for an out-of-state company whose tax advisor has read Telebright.