Being Unemployed, Depressed And Owing The IRS

The case is 55 pages long.

Even a tax guy gets tired of marathon reading.

The story got me fired up, however, so let’s talk about it.

A frequent area of taxpayer request for IRS relief from penalties is rollovers of retirement monies, especially IRAs. Used to be that one filed for a Private Letter Ruling to obtain official absolution. Those bad boys are not cheap, as you will pay a tax CPA or attorney to draft the PLR, as well as pay the IRS filing fee. The filing fee alone can run you $10,000.

In 2016 the IRS published Revenue Procedure 2016-47 allowing for alternate means of absolution without requesting a PLR. Even the IRS got tired of taking your money.

Mr Trimmer was a retired cop with the New York Police Department. He was moving on after 20 years with the NPD, taking a security job with the New York Stock Exchange. He needed the job to supplement his pension, as he had two sons going through college. The new job however fell through. He was hosed, as the NYPD does not rehire.

And Trimmer went major depressive. He was antisocial, rarely left the house, neglected his hygiene and grooming – all the classic symptoms.

Somewhere in there he received two retirement checks: one for $99,990 and a second for $710. They lay on his dresser for weeks until he finally got around to depositing them into … his checking account.

COMMENT: If you were thinking a rollover, he flubbed because the roll did not go into an IRA account.

Months later Trimmer and his wife met with their accountant for their taxes. The accountant advised that he transfer the monies to an IRA immediately.

COMMENT: Trimmer was well outside the 60-day window at that point.

The IRS sent him a notice asserting that he failed to report over $100,000 of income and demanded taxes, penalties, interest, a Weimaraner puppy and a month’s pass to Planet Fitness.

It added up close to $40.000.

Yipes!

Trimmer wrote back to the IRS: 

    Dear Sirs:

I am contesting the amount of money said to be owed. Please allow me to explain the situation. In April 2011 I retired from my job and took a pension loan. After my retirement I went through a period of depression and was not managing my affairs. I received my check for the loan and deposited it into Santander bank on July 5, 2011. The money remained in this account until April of 2012 when it was switched to an I.R.A. in the same bank where it remains to this day.

A few points

- There was no deception or spending, investing of the money at all. I received the check and deposited it into the bank.

- My wife and I have been paying taxes for a combined 60 years and NEVER had the least bit a problem.

- There was no harm done to anyone with the money staying in the bank except me (I was receiving 0.25% interest.)

- I switched the money to an I.R.A. before I was notified by the I.R.S.

I am now employed again and am driving a school bus and have a son in college and another a year away. To pay $40,000 in taxes for money that is in an I.R.A. would absolutely cripple my family as it would be 3 years of my salary. Sir no harm was done to anyone. I went through a rough time upon separation from my job, causing me emotional hard times that caused this situation. Penalizing me and my family would not benefit anybody, only cause extreme duress and punish my children who played no part in this situation. I ask you to consider these facts and please come to a fair decision. Please contact me if you need at [phone number redacted].

Thank You,

John Trimmer

I feel sorry for the guy.

Here is the IRS reply:

“The law requires you to roll over your distribution within 60 days of the distribution date. If the roll over exceeds the time frame it becomes fully taxable.”

Nice folk over there.

Here is the tax issue: The IRS can issue waivers for this penalty, but they did not mention such fact to Mr Trimmer or how to apply for a waiver. Heck, they did not even reference Trimmer’s unfortunate circumstances. A reasonable person could question whether anyone even read his letter.

The IRS sent a Statutory Notice of Deficiency, also known as a 90-day letter.

Trimmer filed with the Tax Court.

The IRS went right for the throat:

•  Trimmer did not follow procedures (Rev Proc 2013-16 for the nerds).
• This made the hardship waiver provision “inapplicable.”
•  Since Trimmer had not pressed the point, there technically had been no “final administrative determination.”
• Without that “final,” the Tax Court had no authority over the case.
• In any event, Trimmer had never explained why he was unable to accomplish the two rollovers within 60 days.
• And where is that puppy?

Well, thank you Darth.

The Tax Court seemed to like Trimmer:

(1) OK, so he did not follow procedures.

(2) Not so quick, Sith Lord. How does the IRS reconcile 2003-16 with the following from the Internal Revenue Manual:

Examiners are given the authority to recommend the proper disposition of all identified issues, as well as any issued raised by the taxpayer.”

(3) The examiner’s authority to consider a hardship waiver “strongly implies” that the taxpayer may request the waiver.

COMMENT: 

(4) From the Court:

As might be expected from a self-represented taxpayer unversed in the technicalities of the tax law, he did not expressly cite section 402(c)(3)(B). But his letter leaves little doubt that he was seeking a hardship waiver of the 60-day rollover requirement….”

(5) The Court points out that the examiner 

… did not decline to consider Mr. Trimmer’ request, did not request that petitioners provide any additional information, and did not advise them that they were required to submit a private letter request or do anything else in particular to have their request considered.”

(6) If anything, the examiner wrote Mr. Trimmer that

… you do not need to do anything else for now. We will contact you within 60 days to let you know what action we are taking.”

(7) And 3 days later the examiner

… wrote petitioners again, denying requested relief, not on the basis that petitioners had requested it in the wrong manner or had provided insufficient information, but on the basis of cursory and incomplete legal analysis that failed to take into account the provision for hardship waivers under section 402(c)(3)(B).”

The Tax Court found in favor of Trimmer. He could do a late rollover. He was not subject to tax or penalty and could keep his Weimaraner puppy.

Good.

But it should not have gone this far. We are not in unexplored tax country here.

One could argue that our tax system is near-to breaking when you have to hire a professional to resolve near-routine tax problems. This man did not roll-over his money within 60 days. He was clinically depressed for a while. I can see requesting a doctor’s letter attesting to the taxpayer’s condition, but this is not cutting-edge tax practice.  

So why the HBO-level drama?

Here is one commentator’s remark:

We have a lazy revenue agent who probably just glances over the response. Is it the revenue agent’s fault? No, I don’t blame the revenue agent. With budget cuts, the caseloads of revenue agents are insane.”

I was listening until the “overworked” card. Seriously? I recommend this revenue agent not consider a career as a tax CPA, although – as a positive – it would probably be a short one.  

I do think our case highlights a disturbingly under-skilled IRS employee.

I also think it shows a trigger-happy IRS assessing penalties on anyone for anything. That examiners are throwing them around like sugar packets from a McDonalds drive-through indicates that they are under pressure to sweeten the take, irrespective of whether penalties are appropriate. Those penalties are under-the-table income to an IRS already facing a tight budget.

We have spoken before of a goose-and-gander bill, requiring the IRS to pay a taxpayer when the agency acts recklessly. The IRS already has people on payroll to pin your ears back, whereas you have to hire someone like me to fend them off. Their incremental cost to chase you is minimal, but your incremental cost to defend yourself can be significant if not ruinous.

Our goose-and-gander bill might or might not have protected Trimmer specifically, but eventually the IRS would lose enough cases to reconsider the automatic-tax-and-penalty-no-reasonable-cause-raised-middle-finger policy it has adopted. Cutting a check really focuses one’s attention.

The Qualified Small Business Stock Exemption

Let’s say that you are going to start your own company. You talk to me about different ways to organize:

(1) Sole proprietor – you wake up in the morning, get in your car and go out there and shake hands. There is no paperwork to file, unless you want to get a separate tax ID number. You and your proprietorship are alter-egos. If it gets sued, you get sued.

(2) Limited liability company – you stick that proprietorship in a single-member LLC, writing a check to your attorney and secretary of state for the privilege. You gain little to nothing tax-wise, but you may have helped your attorney (and yourself) if you ever get sued.

(3) Form a corporation - a corporation is the old-fashioned way to limit your liability. Once again there is a check to your attorney and secretary of state. Corporations have been out there long before LLCs walked the land.

You then have to make a decision as to the tax flavor of your corporation: 

a.    The “C” corporation – think Krogers, Proctor & Gamble and Macy’s. The C is a default for the big boys – and many non-bigs. There are some goodies here if you are into tax-free reorganizations, spin-offs and fancy whatnot.

Problem is that the C pays its own tax. You as the shareholder then pay tax a second time when you take money out (think a dividend) from the C.  This is not an issue when there are a million shareholders. It may be an issue when it is just you.

b.    The “S” corporation – geared more to the closely-held crowd. The S (normally) does not pay tax. Its income is instead included on your personal tax return. Own 65% of an S and you will pay tax on 65% of its income, along with your own W-2, interest, dividends and other income.

This makes your personal return somewhat a motley, as it will combine personal, investment and business income into one. Don’t be surprised if you are considered big-bucks by the business-illiterate crowd.

The S has been the go-to corporate choice for family-owned corporations since I have been in practice. A key reason is avoiding that double-tax.

But you can avoid the double tax by taking out all profits through salaries, right?

There is a nerdy issue here, but let’s say you are right.

Who cares then?

You will. When you sell your company.

Think about it. You spend years building a business. You are now age 65. You sell it for crazy money. The corporation pays tax. It distributes whatever cash it has left-over to you.

You pay taxes again.

And you vividly see the tax viciousness of the C corporation.

How many times are you going to flog this horse? Apple is a multinational corporation with a quarter of a trillion dollars in the bank. Your corporate office is your dining room.

The C stinks on the way out.

Except ….

Let’s talk Section 1202, which serves as a relief valve for many C corporation shareholders when they sell.

You are hosed on the first round of tax. That tax is on the corporation and Section 1202 will not touch it.

But it will touch the second round, which is the tax on you personally.

The idea is that a percentage of the gain will be excluded if you meet all the requirements.

What is the percentage?

Nowadays it is 100%. It has bounced around in prior years, however.

That 100% exclusion gets you back to S corporation territory. Sort of.

So what are the requirements?

There are several:

(1) You have to be a noncorporate shareholder. Apple is not invited to this soiree.

(2) You have owned the stock from day one … that is, when stock was issued (with minimal exceptions, such as a gift).

(3) The company can be only so big. Since big is described as $50 million, you can squeeze a good-sized business in there. BTW, this limit applies when you receive the stock, not when you sell it.

(4) The corporation and you consent to have Section 1202 apply.

(5) You have owned the stock for at least 5 years.

(6) Only certain active trades or businesses qualify.

Here are trades or businesses that will not qualify under requirement (5):

(1) A hotel, motel, restaurant or similar company.

(2) A farm.

(3) A bank, financing, leasing or similar company.

(4) Anything where depletion is involved.

(5) A service business, such as health, law, actuarial science or accounting.

A CPA firm cannot qualify as a Section 1202, for example.

Then there is a limit on the excludable gain. The maximum exclusion is the greater of:

(1) $10 million or

(2) 10 times your basis in the stock

Frankly, I do not see a lot of C’s – except maybe legacy C’s – anymore, so it appears that Section 1202 has been insufficient to sway many advisors, at least those outside Silicon Valley.

To be fair, however, this Code section has a manic history. It appears and disappears, its percentages change on a whim, and its neck-snapping interaction with the alternative minimum tax have soured many practitioners.  I am one of them.

I can give you a list of reasons why. Here are two:

(1) You and I start the company.

(2) I buy your stock when you retire.

(3) I sell the company.

I get Section 1202 treatment on my original stock but not on the stock I purchased from you.

Here is a second:

(1) You and I start the company.

(2) You and I sell the company for $30 million.

We can exclude $20 million, meaning we are back to ye-old-double-tax with the remaining $10 million.

Heck with that. Make it an S corporation and we get a break on all our stock.

What could make me change my mind?

Lower the C corporation tax rate from 35%.

Trump has mentioned 15%, although that sounds a bit low.

But it would mean that the corporate rate would be meaningfully lower than the individual rate. Remember that an S pays tax at an individual rate. That fact alone would make me consider a C over an S.

Section 1202 would then get my attention.

The Foreign Income Exclusion When You Leave Mid-Year

We have a client who worked as a contractor in Afghanistan last year.

Let’s talk foreign income exclusion.

There are ropes.

The first is simple: to get to that exclusion you (a) must be a bona fide resident of a foreign country or (b) you have to be outside the United States for a certain number of days.

The bona fide exception is few and far between, and I doubt Afghanistan-as-a-destination would ever enter the conversation. In my experience, bona fide means a military, military-contractor or foreign service person (or family) who went overseas and did not return. There are only so many of those folks.

Nope, you and I (likely) have to meet a second test: the “physical presence” test. You and I have to be outside the United States for at least 330 days in a 365-day stretch.

A few things about this:

(1) 365 days does not necessarily mean a calendar year. It just needs to be 365 successive days. It does not have to end on December 31 or start on January 1.

(2) Let’s say that you are overseas for years. You can reset that 365-day period every year, as long as you can get to 330 days each time you reset.

(3) It does not mean that you have to be in the same country for 330 days. It just means that you have to be outside the United States. You can travel like a fiend – as long as you do not come back to the U.S.

(4) This is an all-or-nothing test. Botch the 330 days and you get nothing. There is no participation trophy here.

The maximum 2016 foreign income exclusion is $100,800.

Wait! There is a second calculation.

You have to prorate $100,800 by the number of days you were outside the U.S.

Huh?

Leave the U.S. late in the year – say August – and most of the exclusion disappears. Why? An August departure means the most you can claim is 5/12 of the maximum exclusion.

This second calculation very much means a calendar year.

And there you have the reason for much confusion in this area: there are two 12-month tests. The first one does not care whether your 12 months line-up with the calendar. The second one definitely means a calendar year.

Let’s recap:

(1) Take a 365-day period. It does not have to start on January 1; you can start it whenever you want.

a.    You need 330 days.

b.    Implicit in that statement is that some of those 330 days may have occurred in the calendar year before or following. It doesn’t matter. The 365 does not need to be in the same calendar year.

c.     Fail this test and you are done.

d.    Pass this test and you have a shot at winning the $100,800 prize.

(2) Next calculate how many days you were outside the U.S. in 2016. Divide that number by 365, giving you a ratio. We will call the ratio Mortimer.

a.    Multiply Mortimer by $100,800.

b.    The result is your maximum 2016 foreign income exclusion.

The first year can be a tax surprise for an American working overseas. It was for our client.

Why?

He was counting on the full $100,800.

What went wrong?

He did not leave the United States until April.

He was not happy.

When Is A Car Not A Car?

I had a conversation today with someone who wanted to understand the “tax side” of a series of transactions. More specifically, transactions that – to a non-tax person – would appear to have no tax side at all.

It made me think of a tax case I read while grabbing a quick dinner one night during busy season.

          COMMENT: Glamorous life, eh?

Think of your car. In the eyes of the IRS, is it one asset or is it a collection of interdependent systems that – together – form a car but which can be separately depreciated, abandoned, sold or whatnot?

This is easy: it is one asset. You start depreciation on the whole thing and you eventually sell or abandon the whole thing. You are not picking and choosing manifolds from rotors.

Except if ….

It is a race car.

There is a racing team. After each race the team strips down the car, perhaps to the nuts and bolts. They decide as they go though:

(1) Damaged parts

(2) Obsolete parts

a.    There is enough technological change in racing that a part can become obsolete almost overnight.

(3) Stress and wear parts

a.    These are not damaged or obsolete, but the team knows they have very limited life left because of the high stress and wear of racing.

                                                             i.     Some parts can be reused in a race.

                                                           ii.     Some parts cannot be raced again, but would be fine for a show car or pit car.

The team had a question for the IRS: can they deduct some of this stuff when they disassemble the car after every race?

To a tax nerd, the question is whether there has been a “disposition.” That is the trigger that allows one to remove an asset from a depreciation schedule and claim a gain or loss on the tax return – hopefully a loss.

But what does “disposition” mean to a race car?

Turns out that disassembling it after every race is the disposition. The IRS took pains to point out that the same car is never raced twice. Dale Earnhardt Jr races number 88, but you never see the same number 88 twice.

          COMMENT: There is a Zen quality to this.

That makes it easy: if you get rid of a part, you can write-off its remaining cost.

But what if you keep the part?

To phrase it another way: what if you had a disposition but did not, you know, dispose of the part?

Now you have an accounting twist. You value the part at its invoice cost (which is normal) and then adjust down for the amount of useful life already expired. Let’s say you have a $7,500 part, and the team experts say that it has 40% useful life remaining. Well, that part stays on your books at $3,000 ($7,500 times 40%). The other $4,500 gets written-off as a loss.

Heck, you can deduct a loss even if you keep the part!

Rinse and repeat for however many parts make up a race car.

COMMENT: I feel sorry for the person who has to bookkeep for all this.

I wonder if racing aficionados would recognize which racing team the IRS addressed in PLR 201710006.

A PLR is a private letter ruling, meaning that someone presents a situation to the IRS and requests the government position on tax consequences. This is generally done in advance to obtain some certainty to a transaction, especially if there is a lot of money involved.

And PLRs are published. For many years the IRS did not publish them, but there was a famous lawsuit requiring the IRS to do so. There was an issue, however, as the IRS is not allowed to release confidential information. The answer was heavy redaction of any confidential information while drafting the PLR.

Such as the name of the racing team.

Data Security And Your Tax Preparer

I annually reflect on what was unique about every tax season, other than this is a difficult profession. I can understand why accounting graduates increasingly dismiss public accounting as a career choice.

I am concerned with the increasing concentration of confidential information in an accounting office.

We have always had your name, address, birthdate and social security number.

Right there is big bucks to an Eastern European identity thief.

Riding the best-intentions train, you now have states – Tennessee comes to mind – that will not allow you to pay their (Hall) tax with a check. No sir, you have to have that bad boy drafted against your bank account. I understand Tennessee’s position – it is cheaper than handling a check – but I do not care about their position. How dare they coerce you to make it convenient for them to Soprano your money. If it is so much trouble, then stop taking the money!

You have no choice with those states.

So we have your bank information.

We now have additional “identity theft” safeguards. For example, some states require driver’s license information before you can file your return. Wow, I now have a copy of your driver’s license. And your spouse’s, if you are married.

Seems the government has shifted data protection responsibility to your friendly neighborhood tax preparer.

I did not want your data. I still don’t want it, but there it is - on my server.

Which can be carried away in an instant.

How hard would it be for someone to take down my office door, walk to the server, pull out all the wires and walk out with the thing?

And their goes your name, address, birth date, social security number, bank account information, driver’s license, those of your spouse and children, and who knows what else.

Identity thieves are spending way too much time hacking into Target and other major corporations.

It would be easier to break into CPA offices across the fruited plain. One person. One server. Repeat. You could probably knock out a dozen or two in a day.

Thank heavens our government is standing guard over all CPA firm servers in all the offices in all the cities across the land. 

Otherwise we would have reason to be concerned.

IRA or 401(k): Which Is Better If You Get Fired?

Name me a major difference between an IRA and a 401(k).

I will give you the setup.

After 17 years in the construction industry, Mr C lost his job in 2010. He was unemployed for the next year and a half.

Mrs C was also going through a difficult stretch and lost her job. She was eventually reemployed, but at approximately half of her former salary.

Both Mr and Mrs C were age 56.

He depleted his savings. They then turned to the retirement accounts. You know why: they were trying to survive.

Mrs C took out approximately $4,000 from her retirement.

Mr C told his insurance agent to withhold taxes when he took distributions, as he did not want any surprises come tax time. He took monies out at different times, in different amounts and from different accounts. To add to the confusion, he was also sending money back to the insurance agent, presumably to settle-up on the income taxes withheld on the distributions.

All in all, he took out approximately $28,000.

Mr and Mrs C later received 1099s for approximately $17 thousand, which they reported on their tax return.

Question: what happened to the other $11,000 ($28 - $17)?

Who knows.

Unfortunately, the actual distributions taken from the retirement accounts were closer to $32,000.

Real … bad … accounting … happening … here.

But let’s be chivalrous: Mr and Mrs C did not receive all the 1099s. It happens.

The IRS – of course – did receive all the 1099s. They probably also have all the socks that go missing in clothes dryers, too.

And the IRS wanted tax on the $15,000 that Mr and Mrs C did not report.

No surprise.

And 10% penalties.

Must be that “early” distribution thing.

And more penalties on top of that, because that is the way the IRS rolls these days.

Not OK.

Mr and Mrs C represented themselves (“pro se”) at the Tax Court.

And I love their argument:

They had dutifully paid their taxes for more than 30 years without fault or complaint. Could the Court find it in its heart … you know, this one time?

The Court could not grant their argument, as you probably guessed. Thirty years of safe driving doesn’t mean you can go on a society-threatening tear one sodden Saturday night. It just doesn’t work that way.

The Court decided they owed the tax. They also owed the 10% penalty for early distribution.

What they didn’t owe was another IRS penalty on top of that. The Court found that they did the best they could and genuinely believed that the broker was using the monies Mr C forwarded to cover withholding taxes. They were as surprised as anyone when that wasn’t the case. It created a tax hole they could not climb out of, at least not easily.

Here is my question to you:

Did they take monies from their 401(k)s or from their IRAs?

Whatchu think?

I am thinking their IRAs.

Why?

An early distribution from an IRA is defined as age 59 ½. Unless there is an exception (you know, like, you died), you are going to get tagged with that 10% penalty.

On the other hand, the age test for a 401(k) is 55.

The Cs got tagged, thus I am thinking IRA.

To be fair, there is more to this exception. Here are some technicals:

•    It applies only to company sponsored plans, like 401(k)s.
•    It applies only to a plan sponsored by the company that let you go. That 401(k) at a former employer doesn’t qualify.

And here is the biggie:

·       You have to withdraw the money in the same year you are let go. You cannot stagger this over a period of years.

Why that last one?

Seems harsh to me. Isn’t it bad enough to be fired? Why not make it the year of discharge and the year following? Is Congress concerned that getting fired will become the next great tax shelter? How about lifetime pensions for 30+year tax CPAs?

Thought I would slip-in that last one.

Mr and Mrs C were age 56. Old enough for 401(k) relief, but too young for IRA relief.

BTW, if you need money over several years, there may be a way around the “you have to withdraw the money in the year you were let go” requirement.

How?

Roll your 401(k) money into an IRA.

Then start “substantially equal periodic payments” from the IRA. This has its own shortcomings, but it is an option.

And you can withdraw over more than one year without triggering a penalty.

Problem is: you have to withdraw over a minimum number of years and the annual payouts can vary only so much. It is of little help if you need money, lots of it and right now.

I do not believe we have spoken of “substantially equal” payments on this blog before. There is a reason: that is dry country and likely to send both of us into a coma. Let me see if I can find a case that is even remotely interesting. 

Tax Preparers And Making Things Up

The following question came up this year. It was from an experienced CPA, so I was surprised that he even asked:

Are there rules on overstating income on a tax return?

You can anticipate the thought process. It is intuitive why one is not allowed to overstate deductions, as that has the effect of reducing taxes otherwise going to the government. But to overstate income? Why would the government care if you wanted to pay more tax?

Because folks, 999 times out of 1000 that is not the reason someone overstates income.

People do this to tap into the tax-credit-money-goodies in the tax Code. Most credits will reduce your tax, but when you get down to zero tax the credit ends. There are some exceptions. The main one, of course, is the earned income credit, although in recent years the government has added the American Opportunity (usually called the college) and the child tax credits.

The government will send you a check.

The earned income credit has the peculiar feature that the credit increases (as does your refund) as your income increases – up to a point, of course, and then the credit goes away.

I have reached a point in practice where I simply do not accept a client with an earned income credit. Chances are they could not afford my fee, granted, but I have a bigger issue: as a professional preparer, I take on additional penalty exposure by signing a return with this credit. I am “supposed” to perform extra due diligence, such a verifying that there is a child in your house. I have options other than parking across the street from your place overnight to verify your comings and goings, though: I can look at your kid’s report card (if it shows an address) or a doctor’s bill (again, if it shows an address).

Sure, pal. You know what I am not going to do? Prepare your return, that is what I am not going to do.

Unless I have known you for years, and I know that you have had a financial reversal. That is different. My due diligence has already been done and over several years.

There are unscrupulous preparers who do not observe such niceties. One could set up a temporary storefront, crank out a thousand make-believe, earned income/American Opportunity/child credit tax returns, charge a usurious fee (refund anticipation loans are sweet profit), skip town and enjoy the summer at a nice beach.

I knew one of these guys, although his schtick was made-up deductions more than false tax credits. You automatically had business mileage if you were his client. It did not matter if you owned a car.

Oh, did you know that is one way for you to get audited? If the IRS looks at your preparer, your odds of also being audited go up astronomically.

I am looking at a case from my hometown – Tampa, also known as the tax-fraud capital of the nation.

Our protagonist (the “Tax Doctor”) prepared a 2007 return for Shakeena Bryant. She brought a W-2 for less than $200 from Busch Gardens and information regarding her kids.

You are not going to get much of a credit with $200 worth of income.

But the Tax Doctor had a solution: report additional income from a business.

So she went out, got a business license for auto detailing and returned with it to his office the same day.

He then put a bit over $18,000 auto-detailing income on her return.

I suppose business licenses in Tampa also allow one to travel back in time.

Wouldn’t you know she got audited?

The IRS asked her about the auto detailing business.

She told the IRS she did not have an auto detailing business.

The IRS then wanted to talk to the Tax Doctor.

He explained that he “reasonably” relied upon her statements and exercised “due diligence.” He had that license, for example, and two pages of notes. He may also have had a soiled napkin from Dunkin Donuts, but I am not sure.

Out comes the preparer penalty - $2,500 of it.

Then the Tax Doctor – not knowing when to walk away – filed suit to get his $2,500 back.

This was a really bad idea, as it allowed the IRS to depose Ms. Bryant and the friend who accompanied her to the Tax Doctor’s office that day. 

Both testified that the business income idea was his.

The Tax Doctor fired back: he observed the due diligence rules, meaning that he should not be penalized. Why, he had a business license and two pages of notes in his files!

He had a point.

The Court also made a point: Ms. Bryant never talked about an auto-detailing business until he brought up the need for more income to drive the tax credit. Perhaps a reasonable preparer would have asked for documentation …. bank statements, receipts, FaceBook postings, State Department leaks. Folks, it is acceptable for a preparer to use his/her skepticism-radar.

He was reckless.

The Court found intentional disregard of his preparer responsibilities and sustained the penalty.

My thoughts? 

Very little patience. The Tax Doctor got off easy.

A Sad Grandma Story

 You know a tax case is going to irritate when you read this sentence early on:

The Commissioner does not defend the justice of this result, but says the law requires it.”

The story involves a grandmother, a son and daughter-in-law and two grandkids. Grandma appears to be the only one working and that as a nursing assistant in Texas. She also collected social security, which was just enough to keep the household afloat.

          []’s job is hard, and it does not pay much.”

It was 2012. He son did not work. Her daughter-n-law…

          … stayed home and took care of the babies.”

She filed her 2012 tax return and claimed the two grandchildren as dependents. That made sense, as she was the only person there with a job.

This allowed her to claim head of household and the dependent exemptions. Much more important than that, however, it allowed her to claim the child and earned income credits. She got a refund of almost $5,300, almost half of which was those credits.

Good for grandma.

The IRS sent her a notice. They wanted the money from the credits back.

Being the warm, fuzzy IRS we have come to know, she was also assessed a $1,000 penalty.

She figured ID theft. Somebody else must have claimed the kids.

She was right, partially. Somebody else did claim the kids.

Their parents.

That would be her son, the one who …

… did not work, and he was into dealing with drugs.”

Sigh.

We all know what a child is, but in the tax Code must rise to the level of a “qualifying child” before the tax goodies flow. There are requirements, of course – such as age and where they live – and grandma easily met those.

But only one person can claim each qualifying child, which is why one is required to include dependent social security numbers on the return. The IRS tracks those numbers. If you are the second person to use a dependent’s number, the IRS will bounce (or at least hold up) your return.

Grandma was the second to file, so she got bounced.

Now, there are families where more than one person can say that a child was his/her qualifying child. Congress anticipated this and included tie-breaker rules. For example, if two people contest and have equal claim, then the tie-breaker goes to the person with more income.

Or if the parents and someone else claim, then the parents win the tie-breaker.

However, this can be sidestepped if the parents DO NOT claim the child.

In grandma’s case, her son and daughter-in-law filed and claimed.

Can this situation be saved?

You bet.

How?

Amend the return. Have the parents “unclaim” the kids.

To their credit, the son and daughter did amend. They handed the amended return to the IRS attorney.

And here we have the technicality that makes you cringe.

Filing a return means sending it on to a service center or handing it to “any person assigned the responsibility to receive hand-carried returns in the local Internal Revenue Service office.”

Problem: the IRS attorney is not “assigned the responsibility” to receive or handle returns. Handing him/her a return is the equivalent of giving your return to a convenience store clerk or a Starbucks barista.

I suppose the attorney could bail you out by filing the return on your behalf upon returning to the office, but that did not happen here.

The return was never filed. Without an amended return, the son and daughter never revoked their dependency claim.

As the parents, they took priority over grandma, who only supported everyone that year.

And grandma could not claim the kids a second time.

Which cost her the child and earned income credits.

She had to repay the IRS.

The Court did not like this, not even a little bit.

We are sympathetic to []’s position. She provided all the financial support for …, had been told by her son that she should claim the children as her dependents, and is now stuck with a hefty tax bill. It is difficult for us to explain to a hardworking taxpayer like [] why this should be so, except to say that we are bound by the law.”

Sad.

At least the Court reversed those blasted penalties.