90 Days Means 90 Days

Let’s return to an IRS notice we have discussed in the past: the 90-Day letter or Notice of Deficiency. It is commonly referred to as a “NOD” or “SNOD.”

If you get one, you are neck-deep into IRS machinery. The IRS has already sent you a series of notices saying that you did not report this income or pay that tax, and they now want to formally transfer the matter to Collections. They do this by assessing the tax. Procedure however requires them (in most cases) to issue a SNOD before they can convert a “proposed” assessment to a “final” assessment.

It is not fun to deal with any unit or department at the IRS, but Collections is among the least fun. Those guys do not care whether you actually owe tax or have reasonable cause for abating a penalty. Granted, they might work with you on a payment plan or even interrupt collection activity for someone in severe distress, but they are unconcerned about the underlying story.

Unless you agree with the proposed IRS adjustment, you must respond to that SNOD.

That means you are in Tax Court.

Well, sort of.

The IRS will return the case to the IRS Appeals with instructions and the hope that both sides will work it out. The last thing the Tax Court wants is to hear your case.

This week I finally heard from Appeals concerning a filing back in March.

Here is a snip of the SNOD that triggered the filling.

Yeah, no. We are not getting rolled for almost $720 grand.

I mentioned above that this notice has several names, including 90-day letter.

Take the 90 days SERIOUSLY.

Let’s look at the Nutt case.

The IRS mailed the Nutts a SNOD on April 14, 2022 for their 2019 tax year. The 90 days were up July 18, 2022. The 18^th was a Monday, not a holiday in fantasy land or any of that. It was just a regular day.

The Nutts lived in Alabama.

They filed their Tax Court petition electronically at 11.05 p.m.

Alabama.

Central time.

90 days.

The Tax Court is in Washington, D.C.

The Tax Court received the electronic filing at 12.05 a.m. July 19^th.

Eastern time.

91 days.

The Tax Court bounced the petition. Since it had to be filed with the Tax Court - and the Tax Court is eastern time - the 90 days had expired.

A harsh result, but those are the rules.

Our case this time was Nutt v Commissioner, 160 T.C. No 10 (2023).

Failing To Take A Paycheck

I am looking at a case involving numerous issues. The one that caught my attention was imputed wage income from a controlled company in the following amounts:

2004                    $198,740

2005                    $209,200

2006                    $220,210

2007                    $231,800

2008                    $244,000

Imputed wage income means that someone should have received a paycheck but did not.

Perhaps they used the company to pay personal expenses, I think to myself, and the IRS is treating those expenses as additional W-2 income. Then I see that the IRS is also assessing constructive dividends in the following amounts:

2004                    $594,170

2005                    $446,782

2006                    $375,246

2007                    $327,503

2008                    $319,854 

The constructive dividends would be those personal expenses.

What happened here?

Let’s look at the Hacker case.

Barry and Celeste Hacker owned and were the sole shareholders of Blossom Day Care Centers, Inc., an Oklahoma corporation that operated daycare centers throughout Tulsa. Mr. Hacker also worked as an electrician, and the two were also the sole shareholders of another company - Hacker Corp (HC).

The Hackers were Blossom’s only corporate officers. Mrs. Hacker oversaw the workforce and directed the curriculum, for example, and Mr. Hacker was responsible for accounting and finance functions.

Got it. She sounds like the president of the company, and he sounds like the treasurer.

For the years at issue, the Hackers did not take a paycheck from Blossom.

COMMENT: In isolation, this does not have to be fatal.

Rather than pay the Hackers directly, Blossom made payments to HC, which in turn paid wages to the Hackers.

This strikes me as odd. Whereas it is not unusual to select one company out of several (related companies) to be a common paymaster, generally ALL payroll is paid through the paymaster. That is not what happened here. Blossom paid its employees directly, except for Mr. and Mrs. Hacker.

I am trying to put my finger on why I would do this. I see that Blossom is a C corporation (meaning it pays its own tax), whereas HC is an S corporation (meaning its income is included on its shareholders’ tax return). Maybe they were doing FICA arbitrage. Maybe they did not want anyone at Blossom to see how much they made.  Maybe they were misadvised.

Meanwhile, the audit was going south. Here are few issues the IRS identified:

(1)  The Hackers used Blossom credit cards to pay for personal expenses, including jewelry, vacations, and other luxury items. The kids got on board too, although they were not Blossom employees.

(2)  HC paid for vehicles it did not own used by employees it did not have. We saw a Lexus, Hummer, BMW, and Cadillac Escalade.

(3) Blossom hired a CPA in 2007 to prepare tax returns. The Hackers gave him access to the bank statements but failed to provide information about undeposited cash payments received from Blossom parents.

NOTE: Folks, you NEVER want to have “undeposited” business income. This is an indicium of fraud, and you do not want to be in that neighborhood.

(4)  The Hackers also gave the CPA the credit card statements, but they made no effort to identify what was business and what was family and personal. The CPA did what he could, separating the obvious into a “Note Receivable Officer” account. The Hackers – zero surprise at this point in the story - made no effort to repay the “Receivable” to Blossom.  

(5) Blossom paid for a family member’s wedding. Mr. Hacker called it a Blossom-oriented “celebration.”  

(6) In that vein, the various trips to the Bahamas, Europe, Hawaii, Las Vegas, and New Orleans were also business- related, as they allowed the family to “not be distracted” as they pursued the sacred work of Blossom.

There commonly is a certain amount of give and take during an audit. Not every expense may be perfectly documented. A disbursement might be coded to the wrong account. The company may not have charged someone for personal use of a company-owned vehicle. It happens. What you do not want to do, however, is keep piling on. If you do – and I have seen it happen – the IRS will stop believing you.

The IRS stopped believing the Hackers.

Frankly, so did I.

The difference is, the IRS can retaliate.

How?

Easy.

The Hackers were officers of Blossom.

Did you know that all corporate officers are deemed to be employees for payroll tax purposes? The IRS opened a worker classification audit, found them to be statutory employees, and then went looking for compensation.

COMMENT: Well, that big “Note Receivable Officer” is now low hanging fruit, isn’t it?

Whoa, said the Hackers. There is a management agreement. Blossom pays HC and HC pays us.

OK, said the IRS: show us the management agreement.

There was not one, of course.

These are related companies, the Hackers replied. This is not the same as P&G or Alphabet or Tesla. Our arrangements are more informal.

Remember what I said above?

The IRS will stop believing you.

Petitioner has submitted no evidence of a management agreement, either written or oral, with Hacker Corp. Likewise, petitioner has submitted no evidence, written or otherwise, as to a service agreement directing the Hackers to perform substantial services on behalf of Hacker Corp to benefit petitioner, or even a service or employment agreement between the Hackers and Hacker Corp.”

Bam! The IRS imputed wage income to the Hackers.

How bad could it be, you ask. The worst is the difference between what Blossom should have paid and what Hacker Corp actually paid, right?

Here is the Court:

Petitioner’s arguments are misguided in that wages paid by Hacker Corp do not offset reasonable compensation requirements for the services provided by petitioner’s corporate officers to petitioner.”

Can it go farther south?

Respondent also determined that petitioner is liable for employment taxes, penalties under section 6656 for failure to deposit tax, and accuracy-elated penalties under section 6662(a) for negligence.”

How much in penalties are we talking about?

2005                    $17,817

2006                    $18,707

2007                    $19,576

2008                    $20,553

I do not believe this is a case about tax law as much as it is a case about someone pushing the boundary too far. Could the IRS have accepted an informal management agreement and passed on the “statutory employee” thing? Of course, and I suspect that most times out of ten they would. But that is not what we have here. Somebody was walking much too close to the boundary - if not walking on the fence itself - and that somebody got punished.

Our case this time was Blossom Day Care Centers, Inc v Commissioner, T.C. Memo 2021-86.

It’s A Trap

Let’s talk about an IRS trap.

It has to do with procedure.

Let’s say that the you start receiving notices from the IRS. You ignore them, perhaps you are frightened, confused or unable to pay.

Granted, I would point out that this is a poor response to the chain-letter sequence you will be receiving, but it is a human response. It happens more frequently than you might think. Too many times I have been brought into these situations rather late, and sometimes options are severely limited.

The BIG notice from the IRS is called a 90-day letter, also known as a Statutory Notice of Deficiency. Tax nerds refer to it as a SNOD.

This is the final notice in the chain-letter sequence, so one would have been receiving correspondence for a while. The IRS is going to assess, and one has 90 days to file with the Tax Court.

Assessment means that the IRS has 10 years to collect from you. They can file a lien, for example, and damage your credit. They might levy or garnish, neither of which is a good place to be.

I have sometimes used a SNOD as a backdoor way to get to IRS appeals. Perhaps the taxpayer had ignored matters until it reached critical mass, or perhaps the first Appeals had been missed or botched. I had a first Appeals a few years back with a novice officer, and her lack of experience was the third party on our phone call.

Let the 90 days run out and the Tax Court cannot hear the case.

NOTE: Most times a Tax Court filing never goes to court. The Tax Court does not want to hear your case, and the first thing they do is send it back to Appeals. The Court wants to machinery to solve the issue without them getting involved.

Our case this time involves Caleb Tang. He filed pro se with the Tax Court, meaning that he represented himself. Technically Caleb does not have to go by himself – he can hire someone like me – but there are limitations.  

There is a game here, and the IRS has used the play before.

The taxpayer makes a mistake with the filing. In our story, Caleb filed but he forgot to pay the filing fee.

Technically this means the Court would not have jurisdiction.

Caleb also filed an amended return.

As I said, sometimes there are few good options.

The IRS contacted Caleb and said that they would not process his amended return unless he dropped the Tax Court petition.

Trap.

You see, Caleb was past the 90-day window. If he dropped his filing, the IRS would automatically get its assessment, and Caleb would have no assurance they would process his amended return.

Caleb would then not be able to get back to Tax Court. Procedure requires that he pay the tax and then sue in District Court or Court of Federal Claims. There is no pro se in that venue, and Caleb would have no choice but to hire an attorney.

That will weed out a lot of people.

Fortunately, the Court (Chief Judge L Paige Marvel) knew this.

He allowed Caleb additional time to pay his application fee.

Meaning that the case got into the Tax Court’s pipeline.

What happens next?

It could go three different ways:

(1) Both parties drop the case.

(2) They do not drop the case and the matter goes back to Appeals.

(3) The Court hears the case.

I suspect the IRS will process Caleb’s amended return now.

Phone Call About The Statute Of Limitations

Recently I received a call from another CPA. 

He is representing in a difficult tax audit, and the IRS revenue agent has requested that the client extend the statute of limitations by six months. The statute has already been extended to February, 2016, so this extension is the IRS’ second time to the well. The client was not that thrilled about the first extension, so the conversation about a second should be entertaining.

This however gives us a chance to talk about the statute of limitations.

Did you know that there are two statutes of limitations?

Let’s start with the one commonly known: the 3-year statute on assessment.

You file your personal return on April 15, 2015. The IRS has three years from the date they receive the return to assess you. Assess means they formally record a receivable from you, much like a used-car lot would. Normally – and for most of us – the IRS recording receipt by them of our tax return is the same as being assessed. You file, you pay whatever taxes are due, the IRS records all of the above and the matter is done.    

Let’s introduce some flutter into the system: you are selected for audit.

They audit you in March, 2017. What should have been an uneventful audit turns complicated, and the audit drags on and on. The IRS knows that they have until April, 2018 on the original statute (that is, April 15, 2015 plus 3 years), so they ask you to extend the statute.

Let’s say you extend for six months. The IRS now has until October 15, 2018 to assess (April 15 plus six months). It buys them (and you) time to finish the audit with some normalcy.

The audit concludes and you owe them $10 thousand. They will send you a notice of the audit adjustment and taxes due. If you ignore the first notice, the IRS will keep sending notices of increasing urgency. If you ignore those, the IRS will eventually send a Statutory Notice of Deficiency, also known as a SNOD or 90-day letter.

That SNOD means the IRS is getting ready to assess. You have 90 days to appeal to the Tax Court. If you do not appeal, the IRS formally assesses you the $10 thousand.

And there is the launch for the second statute of limitations: the statute on collections. The IRS will have 10 years from the date of assessment to collect the $10 thousand from you.

So you have two statutes of limitation: one to assess and another to collect. If they both go to the limit, the IRS can be chasing you for longer than your kid will be in grade and high school.

What was I discussing with my CPA friend? 

• What if his client does not (further) extend the statute?

Well, let’s observe the obvious: his client would provoke the bear. The bear will want to strike back. The way it is done – normally – is for the bear to bill you immediately for the maximum tax and penalty under audit. They will spot you no issues, cut you no slack. They will go through the notice sequence as quickly as possible, as they want to get to that SNOD. Once the IRS issues the SNOD, the statute of limitations is tolled, meaning that it is interrupted. The IRS will then not worry about running out of time - if only it can get to that SNOD.

It is late August as I write this. The statute has already been extended to February. What are the odds the IRS machinery will work in the time remaining?

And there you have a conversation between two CPAs.

I myself would not provoke the bear, especially in a case where more than one tax year is involved. I view it as climbing a tree to get away from a bear. It appears brilliant until the bear begins climbing after you. 

I suspect my friend’s client has a different temperament. I am looking forward to see how this story turns out.

Is It A Bad Thing To Be A Resident Of Two States At The Same Time?

A state tax issue came up with a client recently, and I was somewhat surprised by another CPA’s response.  The issue arises when someone has tons of interest and dividend income – that is, big bucks, laden with loot, banking the Benjamins.  Since I consider myself a future lottery winner, it also means something to me.

Here it is:

           

Can you be a resident of two states at the same time?

The other CPA did not think it possible.

There are a couple of terms in this area that we should review: domicile and place of abode. Granted in most cases they would mean the same thing. For the average person domicile is where you live. You are a resident of where your domicile is located. We future lottery winners however frequently will have multiple homes.   I intend to have a winter home (New Mexico comes to mind), a summer home (I am thinking Hawaii) and, of course, one or more homes overseas. Which one is my domicile? Now the issue is not so clear-cut.

OBSERVATION: Let’s be honest: this is a high-end tax problem.

Domicile is your permanent home. It is the place to which you intend to return when absent, to which your memories return when away, it is home and hearth, raising children, Christmas mornings and planting young trees There can be only one. A domicile exists until it is superseded, and there can never be two concurrent domiciles. It is Ithaca to Odysseus. It took Odysseus ten years to get home from Troy, but his domicile was always Ithaca. The concept borders on the mystical.

A place of abode can be an apartment, a cottage, a yacht, a detached single-family residence. There can be more than one. I intend to have abodes in New Mexico, Hawaii and possibly Ireland. My wife may pick out another one or two.

Most states (approximately 30, I believe) use the concept of “domicile” to determine whether you are or are not a “resident” of the state. You can generally plan for these states by pinning down someone’s “main” house.  A state can tax all the income of a resident, which is what sets up the tax issue we are talking about.

Then you have the “statutory” states, among the most aggressive of which is New York. New York will consider you a resident if:

(a)  Your domicile is New York, or

(b) Your domicile is not New York, but

a.     You maintain a permanent abode in New York for more than 11 months of the year, and

b.     You spend more than 183 days in New York during the year

That “or” is not there because New York wants to be your friend. That (b) is referred to as statutory residency. It is intentional, and its intent is to lift your wallet.

How? It has to do with all those interest and dividends we future lottery winners will someday have.

Let’s say that you live in Connecticut and work in White Plains. You are going to easily meet the “more than 183 days in New York” test. Unless you work at home. A lot. Let’s say you don’t.

We next have to review if you have a “permanent abode.” What if you have a vacation home in the Hamptons. What if you have an apartment in Brooklyn. What if you rent an apartment (in your name) for your daughter while she is attending Syracuse University. Do you have a permanent abode in New York? You bet you do. The “permanent” just means that it can be used over four seasons. We already discussed the meaning of “abode.”

Think about that for a moment. You may never stay at your daughter’s apartment. It will however be enough for New York to drag you in as a statutory resident because you “maintain” it.  New York doesn’t care if you ever actually stay there – or even step foot in it.

Great. You are a resident of both Connecticut and New York.

So what, you think. Connecticut will give you a credit for taxes paid New York. New York will give you a credit for taxes paid Connecticut. The accountants’ fee will be wicked, but you are not otherwise “out” anything, right?

Wrong. You may be “out” a lot, and it has to do with those interest and dividends and royalties and capital gains – that is, your “investment income.”

There is a state tax concept called “mobilia sequuntur personam.” It means “movables follow the person,” and in the tax universe it means that movable income (think investment income, which can be “moved” to anywhere on the planet) is taxed only by one’s state of residence. The system works well enough when there is only one state in the picture. It may not work so well when there are two states.

The reason is the common technical wording for the state resident tax credit. Let’s look at New York’s wording as our example:

A resident shall be allowed a credit …for any income tax imposed for the taxable year by another state …. upon income both derived therefrom and subject to tax under this article."

The trap here is the phrase “derived therefrom.” Let’s trudge through a New York tax Regulation to see this jargon in its natural environment:

           

The term income derived from sources within another state … is construed as ... compensation for personal services performed in the other jurisdiction, income from a trade, business or profession carried on in the other jurisdiction, and income from real or tangible personal property situated in the other jurisdiction."

Well, isn’t that a peach? New York wants my interest and dividend income to be from personal services I perform (that’s a “no”), from a trade, business or profession (another “no”) or from real or tangible property (again a “no”).

New York will not give me a resident credit for taxes paid Connecticut.

That means double state taxation. 

Yippee.

Can this be constitutional? Yes, unfortunately. The Supreme Court long ago decided that the constitution does not prohibit two states reaching the conclusion that each is the taxpayer’s state of residence. The Court stated:

“[n]either the Fourteenth Amendment nor the full faith and credit clause … requires uniformity of different States as to the place of domicile, where the exertion of state power is dependent upon domicile within its boundaries.” (Worcester County Trust Co v Riley)

What did we advise? The obvious advice: do NOT be in New York for more than 183 days in a calendar year NO MATTER WHAT. 

Our client’s apartment is in Manhattan, so she also gets to pay taxes to New York City on top of the taxes to New York State. I hope she really likes that apartment.

BTW New York is NOT on my list of states for when that future lottery comes in.