I think it
was November or December of last year that I met with a client. He was “behind”
on his taxes, and he now wanted to do the right thing and catch up. He passed me a Form 1099, which he described
as bogus. It had his name and social security number, but he swore he did not
know the payor or provide any services for them.
Could be.
Mistakes happen all the time.
I am
reviewing the Tax Court summary opinion in Furnish
v Commissioner. It is not a technically difficult case – the “summary” part
tells you that – but it made me think of my client.
Furnish is
an actuary.
QUESTION: Do you know what an actuary does? These guys/gals
bring math, statistics and financial modeling to bear in measuring and predicting
uncertain outcomes. They may work for insurance companies, for pension plans,
for banks and investment firms. Think of them as the Sheldon Coopers of the
business world.
Furnish had bought
life insurance policies back when. He used policy dividends to buy additional
coverage over the years, and he thereafter used policy loans to pay premiums on
some or all of the policies. If you use loans to pay premiums for long enough,
the policy will eventually burnout. This means it runs out of money. The
insurance company will then shut down the policy. It happens with some
frequency.
This happened to Furnish. The insurance company then sent him a Form 1099 saying that he had $49,255 as taxable income from the burnout.
QUESTION:
How can you have income from a burnout?
ANSWER: There are three pieces to the answer: (1) you have
written checks for the policy over the years. The total amount of checks is
your “basis” in the policy; (2) you have loans on the policy; (3) the policy
has built-up “cash value” over the years. When the policy burns out, the cash
value is used to pay off the loans. If that cash value exceeds your basis, you
have income. “Phantom” income perhaps, but still income.
Furnish doesn’t buy into the $49,255
at all. He contacts the insurance company and requests files and records back to the
beginning of time. The insurance company had a problem, as those old files were
nonelectronic and not easily retrieved.
The insurance company wants nothing
to do with this guy. Their letters to him went something like “We are right.
Why do you keep bothering us?”
Ah, but they were dealing with an
actuary.
Furnish sends the IRS two tax
returns: one reporting the $49,255 and one not reporting and explanations for each. I
presume he did not have professional advice to handle it in this manner, but so
be it. The IRS of course accepts the one with the $49,255 reported in income.
PAUSE: I’ll give you a moment to get over your shock.
The IRS wanted their money. Furnish
tells the IRS that the insurance company was full of bunkum and the 1099 was
incorrect. The IRS tells Furnish to have the insurance company correct their paperwork. Until then, the IRS wanted their money. Eventually Furnish took the
matter to the Taxpayer Advocate.
No dice with the Advocate and the matter
went before a Tax Court judge. At play is Code Section 6201(d), which reads:
In any court proceeding, if a taxpayer asserts a reasonable
dispute with respect to any item of income reported on an information return
field with the Secretary *** by a third party and the taxpayer has fully
cooperated with the Secretary (including providing, within a reasonable period
of time, access to and inspection of all witnesses, information, and documents
within the control of the taxpayer as reasonably requested by the
Secretary), the Secretary shall have the
burden of producing reasonable and probative information concerning such
deficiency in addition to such information return.”
Furnish argued that he met the
requirements of Section 6201(d). The IRS argued that he had not; that he raised
the issue too late in the proceedings; that he showed only minor calculation
issues; and that Furnish had bad breath. The only evidence the IRS presented
was a declaration by an insurance company employee, agreeing that Furnish did
in fact have bad breath.
The Court decided that Furnish had
raised enough doubt whether the Form 1099 income could be materially incorrect,
and that Furnish had interacted reasonably in providing information and
otherwise responding to the IRS. Furnish had met the requirements of Section
6201(d), and the burden of proof shifted to the IRS.
The IRS, having presenting no
additional evidence beyond a Form 1099 and a letter from the insurance company,
lost. They did not meet the burden of proof.
CONCLUSION: Some commentators consider this decision an
outlier, and the judge has taken criticism in the literature. My experience is for
the IRS to require the taxpayer to have the issuer either void or amend the disputed
information form. Makes sense, in truth. Many times the issuer will, but then there
are those hard-luck cases. Furnish
gives practitioners an option to consider.
