A Puff Piece

 

Although we do not condone her inconsistency, we find it is merely puffery in an attempt to obtain new employment and of no significance here.”

There is a word one rarely sees in tax cases: puffery.

Puffery is an exaggeration. It approaches a lie but stops short, and presumably no “reasonable” person would believe what is being said or take it literally. The distinction matters if one’s puffery can be used against them as a statement of fact.

Let’s look at the Robinson case.

Mr Robinson had a lawn care business. Beverly Robinson had a job at Georgia Pacific, but in 2007 she started working at the lawn care business. She did the billing. She was also listed on the business checking account, but she never wrote checks.

She must have been the face of the business through, as for 2007 through 2009 most of the Forms 1099 to the business were sent in her name.

In 2010 the marriage went south. Mr Robinson moved out, and Beverly’s dad chipped-in to pay the mortgage on her house. Needless to say, she was not working at the company with all that going on.

In 2011 they filed a joint tax return for 2010. The return showed tax due of approximately $43 grand. She must have separated hard from the business, as no Forms 1099 were issued to her; all the Forms 1099 were issued to him.

COMMENT: I do not understand filing a joint tax return with someone you are likely to divorce. In Beverly’s defense, though, she did not realize that she had an option. They hired a tax preparer (likely because of the business), but the preparer never explained that the option to file separately existed.

In 2011 she was telling the IRS that they could not pay the 2010 tax debt. She also asked about innocent spouse status.

In 2012 they file a joint 2011 tax return. She was working again at another Georgia Pacific facility and had tax withholdings. The IRS took her withholdings and applied them to the 2010 tax year.

COMMENT: That is how it works.

In 2013 Beverly needed to find a new job. She uploaded her resume on a jobseeker website. She listed her Georgia Pacific gig. She also listed Robinson Lawn Care and embellished her duties, especially glossing over the fact that she no longer worked there.

In 2013 Mr Robinson somehow forced his way back into her house. She called the police and was told that they could not evict him since the two were still married.

In October, 2013 she filed a petition for dissolution of marriage.

About time. The year before Mr Robinson had fathered a child with another woman. In 2013 he started paying her child support.

The divorce became final in 2014. Mr Robinson agreed to assume the 2010 tax due.

Riiiight.

In 2015 she files for innocent spouse because of that 2010 tax debt and the IRS continuing to take her refunds.

The IRS turned down her request.

One of the requirements is that the tax liability for which the spouse is seeking relief belong to the “nonrequesting” spouse. In this case, the nonrequesting spouse was Mr Robinson.

He testified that he had moved out of the house in 2013. Oh, he also remembered Beverly working in the business in 2010.

Not good.

The IRS looked at certain Florida registrations that showed her name through 2014.

They also pointed out that she was a signatory on the business checking account.

Then they looked at her resume on that jobseeker website.

The Court was having none of it.

As for Mr Robinson:

Throughout the trial Mr. Robinson’s testimony was relatively inconsistent, and we give it little value.”

As for the registrations:

Although petitioner is listed as the registered owner of Robinson Lawn Care from December 1998 to December 2014, we find the reason for her filing the fictitious name--that her former husband worked during the day--is a sufficient explanation for why she is listed instead of Mr. Robinson. Moreover, she did not sign any State filings in 2010 or thereafter.

As for the checking account:

Similarly we find that petitioner’s name on the business account is not persuasive support for respondent’s position as Mr. Robinson had control of that account and she never wrote checks on it.

The Court pointed out that none of the 2010 Forms 1099 were made out to her, in clear contrast to prior tax years.

We saw above the Court’s comment on her puffery.

It was clear who the Court believed – and did not believe.

The Court decided that she was entitled to innocent spouse relief.

She cut it close, though.

Our case this time was Beverly Robinson v Commissioner of Internal Revenue T.C. Memo 2020-134.

FICA Tax On Nonqualified Deferred Compensation

 

One of the accountants brought me what she considered an unusual W-2.

Using accounting slang, Form W-2 box 1 income is the number you include on your income tax return. Box 3 income is the amount on which you paid social security tax.  There often is a difference. A common reason is a 401(k) deferral – you pay social security tax but not income tax on the 401(k) contribution.

She had seen fact pattern that a thousand times. What caught her eye was that the difference between box 1 and box 3 income was much too large to just be a 401(k). 

Enter the world of nonqualified deferred compensation.

What is it?

Let’s analyze the term backwards:

·      It is compensation, meaning that there is (or was) an employment relationship.

·      There is a lag in the payment. It might be that the employee wants the lag; it might be that the employer wants the lag. A common example of the latter is a handcuff: the employee gets a bonus for remaining with the company a while.

·       The arrangement does not meet the requirements of standardized deferred compensation plans, such as a profit-sharing or 401(k) plan. You have one of those and tax Code requires to you include certain things and exclude others. That standardization is what makes the plan “qualified.”

A common type of nonqual (yep, that is what we call it) is a SERP – supplemental executive retirement plan. Get to be a big cheese at a big company (think Proctor & Gamble or FedEx) and you probably have a SERP as part of your compensation package.

I wish I had those problems. Not a big company. Not a big cheese.

Let’s give our mister big cheese a name: Gouda.

Gouda has a nonqual.

The taxation of a nonqual is a bit nonintuitive: the FICA taxation does not necessarily coincide with its income taxation.

Let’s run through an example. Gouda has a SERP. It vests at one point in time- say 5 years from now. It will not however be paid until Gouda retires or otherwise separates from service.

Unless something goes horribly wrong. Gouda does not have income tax until he receives the money. That might be 5 years from now or it might be 20 years.

Makes sense.

The FICA tax is based on a different trigger: when does Gouda have a right to the money?

Think of it like this: when can Gouda sue if the company fails to pay him? That is the moment Gouda “vests” in the SERP. He has a right to the money and – barring the exceptional – he cannot be stripped of this right.

In our example, Gouda vests in 5 years.

Gouda will pay social security and Medicare (that is, FICA) tax in 5 years.

It is what sets up the weird-looking Form W-2. Let’s say the deferred compensation is $100 grand. The accountant is looking at a W-2 where box 3 income is (at least) $100 grand higher than box 1 income (remember: box 1 is income tax and Gouda will not pay income tax until gets the money).

There is even a name for this accounting: the “Special Timing Rule.”

Why does this rule exist?

You know why: the government wants its money - at least some of it.

But if you think about it, the special timing rule can be beneficial to the employee. Say that Gouda is drawing a nice paycheck: $400 grand. The social security wage base for 2020 is $137,700. Gouda is way past paying the full-boat 7.65% FICA tax. He is paying only the Medicare portion of the FICA - which is 1.45%. If the IRS waited until he retired, odds are the Gouda would not be working and would therefore have to pay the full-boat 7.65% (up to the wage limit, whatever that amount is at the time).

Can Gouda get stiffed by the special timing rule?

Oh yes.

Let’s look at the Koopman v United States case.

Mr Koopman retired from United Airlines in 2001. He paid FICA tax (pursuant to the special timing rule) on approximately $415 grand.

In 2002 United Airlines filed for bankruptcy.

It took a few years to shake out, but Mr Koopman finally received approximately $248 grand of what United had promised him.

This being a tax blog, you know there is a tax hook somewhere in there.

Mr Koopman wanted the excess FICA he had paid. He paid FICA on $415 grand but received only $248 grand.

In 2007 Koopman filed a refund claim for that excess FICA.

Does he have a chance?

Mr Koopman lost, but he did not lose because of the general rule or special rule or any of that. He lost for the most basic of tax reasons: one only has 3 years (usually) to amend a return and request a refund. He filed his refund request in 2007 – much more than 3 years after his withholdings in 2001.

Is there something Koopman could have done?

Yes, but he still could not wait until 2007. He would have had to do it by 2004 – the magic three years.

What could he have done?

File a protective refund claim.

I do not believe we have talked before about protective claims. It is a specialized technique, and an accountant can go a career and never file one.

I believe we have a near-future blog topic here. Let me see if I can find a case involving protective claims that you might want to read and I would want to write.

No Shareholder, No S Corporation Election

 Our case this time takes us to Louisville.

There is a nonprofit called the Waterfront Development Corporation (WDC). It has existed since 1986, and its mission is to development, redevelop and revitalize certain industrial areas around the Ohio river downtown. I would probably shy away from getting involved - anticipating unceasing headaches from the city, Jefferson county and the Commonwealth of Kentucky - but I am glad that there are people who will lift that load.

One of those individuals was Clinton Deckard, who wanted to assist WDC financially, and to that effect he formed Waterfront Fashion Week Inc. (WFWI) in 2012. WFWI was going to organize and promote Waterfront Fashion Week – essentially a fundraiser for WDC.

Seems laudable.

Mr Deckard had been advised to form a nonprofit, on the presumption that a nonprofit would encourage people and businesses to contribute. He saw an attorney who organized WFWI as a nonprofit corporation under Kentucky statute.

Unfortunately, Waterfront Fashion Week failed to raise funds; in fact, it lost money. Mr Deckard wound up putting in more than $275,000 of his own money into WFWI to shore up the leaks. There was nothing to contribute to WDC.  What remained was a financial crater-in-the-ground of approximately $300 grand. Whereas WFWI had been organized as a nonprofit for state law purposes, it had not obtained tax-exempt status from the IRS. If it had, Mr Deckard could have gotten a tax-deductible donation for his generosity.

COMMENT: While we use the terms “nonprofit” and “tax-exempt” interchangeably at times, in this instance the technical difference is critical. WFWI was a nonprofit because it was a nonprofit corporation under state law. If it wanted to be tax-exempt, it had to keep going and obtain exempt status from the IRS.  One has to be organized under as a nonprofit for the IRS to consider tax-exempt status, but there also many more requirements.

No doubt Mr Deckard would have just written a check for $275 grand to WDC had he foreseen how this was going to turn out. WDC was tax-exempt, so he could have gotten a tax-deductible donation. As it was, he had ….

…. an idea. He tried something. WFWI had never applied for tax-exempt status with the IRS.

WFWI filed instead for S corporation status. Granted, it filed late, but there are procedures that a knowledgeable tax advisor can use. Mr Deckard signed the election as president of WFWI. An S election requires S corporation tax returns, which it filed. Mind you, the returns were late – the tax advisor would have to face off against near-certain IRS penalties - but it was better than nothing.

Why do this?

An S corporation generally does not pay tax. Rather it passes its income (or deductions) on to its shareholders who then include the income or deductions with their other income and deductions and then pay tax personally on the amalgamation

It was a clever move.

Except ….

Remember that the attorney organized WFWI as a nonprofit corporation under Kentucky statute.

So?

Under Kentucky law, a nonprofit corporation does not have shareholders.

And what does the tax Code require before electing S corporation status?

Mr Deckard has to be a shareholder in the S corporation.

He tried, he really did. He presented a number of arguments that he was the beneficial owner of WFWI, and that beneficial status was sufficient to allow  an S corporation election.

But a shareholder by definition would get to share in the profits or losses of the S corporation. Under Kentucky statute, Mr Deckard could NEVER participate in those profits or losses. Since he could never participate, he could never be a shareholder as intended by the tax Code. There was no shareholder, no S corporation election, no S corporation – none of that.

He struck out.

The sad thing is that it is doubtful whether WFWI needed to have organized as a nonprofit in the first place.

Why do I say that?

If you or I make a donation, we need a tax-exempt organization on the other side. The only way we can get some tax pop is as a donation.

A business has another option.

The payment could just be a trade or business expense.

Say that you have a restaurant downtown (obviously pre-COVID days). You send a check to a charitable event that will fill-up downtown for a good portion of the weekend. Is it a donation? Could be. It could also be just a promotion expense – there are going to be crowds downtown, you are downtown, people have to eat, and you happen to be conveniently located to the crowds. Is that payment more-than-50% promotion or more-than-50-% donation?

I think of generosity when I think of a donation. I think of return-on-investment when I think of promotion or business expenses.

What difference does it make? The more-than-50% promotion or business deduction does not require a tax-exempt on the other side. It is a business expense on its own power; it does not need an assist.

I cannot help but suspect that WFWI was primarily recruiting money from Louisville businesses. I also suspect that many if not most would have had a keen interest in downtown development and revitalization. Are we closer to our promotion example or our donation example?

Perhaps Mr Deckard never needed a nonprofit corporation.

The Tax Doctrine Of The Fruit And The Tree

 

I am uncertain what the IRS saw in the case. The facts were very much in the taxpayer’s favor.

The IRS was throwing a penalty flag and asking the Court to call an assignment of income foul.

Let’s talk about it.

The tax concept for assignment-of-income is that a transaction has progressed so far that one has – for all real and practical purposes – realized income. One is just waiting for the check to arrive in the mail.

But what if one gives away the transaction – all, part or whatever – to someone else? Why? Well, one reason is to move the tax to someone else.

A classic case in this area is Helvering v Horst. Horst goes back to old days of coupon bonds, which actually had perforated coupons. One would tear-off a coupon and redeem it to receive an interest check. In this case the father owned the bonds. He tore off the coupons and gave them to his son, who in turn redeemed them and reported the income. Helvering v Horst gave tax practitioners the now-famous analogy of a tree and its fruit. The tree was the bond, and the fruit was the coupon. The Court observed:

… The fruit is not to be attributed to a different tree from that on which it grew.”

The Court decided that the father had income. If he wanted to move the income (the fruit) then he would have to move the bond (the tree).

Jon Dickinson (JD) was the chief financial officer and a shareholder of a Florida engineering firm. Several shareholders – including JD – had requested permission to transfer some of their shares to the Fidelity Charitable Gift Fund (Fidelity). Why did they seek permission? There can be several reasons, but one appears key: it is Fidelity’s policy to immediately liquidate the donated stock. Being a private company, Fidelity could not just sell the shares in the stock market. No, the company would have to buy-back the stock. I presume that JD and the others shareholders wanted some assurance that the company would do so.

JD buttoned-down the donation:

·      The Board approved the transfers to Fidelity.

·      The company confirmed to Fidelity that its books and records reflected Fidelity as the new owner of the shares.

·      JD also sent a letter to Fidelity with each donation indicating that the transferred stock was “exclusively owned and controlled by Fidelity” and that Fidelity “is not and will not be under any obligation to redeem, sell or otherwise transfer” the stock.

·      Fidelity sent a letter to JD after each donation explaining that it had received and thereafter exercised “exclusive legal control over the contributed asset.”

So what did the IRS see here?

The IRS saw Fidelity’s standing policy to liquidate donated stock. As far as the IRS was concerned, the stock had been approved for redemption while JD still owned it. This would trigger Horst – that is, the transaction had progressed so far that JD was an inextricable part. Under the IRS scenario, JD would have a stock redemption – the company would have bought-back the stock from him and not Fidelity – and he would have taxable gain. Granted, JD would also have a donation (because he would have donated the cash from the stock sale to Fidelity), but the tax rules on charitable deductions would increase his income (for the gain) more than the decrease in his income (for the contribution). JD would owe tax.

The Court looked at two key issues:

(1)  Did JD part with the property absolutely and completely?

This one was a quick “yes.” The paperwork was buttoned-up as tight as could be.

(2)  Did JD donate the property before there was a fixed and determinable right to sale?

You can see where the IRS was swinging. All parties knew that Fidelity would redeem the stock; it was Fidelity’s policy. By approving the transfer of shares, the company had – in effect – “locked-in” the redemption while JD still owned the stock. This would trigger assignment-of-income, argued the IRS.

Except that there is a list of cases that look at formalities in situations like this. Fidelity had the right to request redemption – but the redemption had not been approved at the time of donation. While a seemingly gossamer distinction, it is a distinction with tremendous tax weight. Make a sizeable donation but fail to get the magic tax letter from the charity; you will quickly find out how serious the IRS is about formalities. Same thing here. JD and the company had checked all the boxes.

The Court did not see a tree and fruit scenario. There was no assignment of income. JD got his stock donation.

Our case this time was Dickinson v Commissioner, TC Memo 2020-128.

Losing A Tax Exemption

The taxation of tax-exempts can sometimes be tricky.

The reason is that a tax-exempt can – depending on the facts – owe income tax. This type of income is referred to as unrelated business income, and the tax issue developed because Congress did not want tax-exempts to mimic the activities of for-profit companies while not paying tax.

There are certain areas – such as permitting third-party use of membership data – that can trigger the unrelated business tax.

Another would be the rental of real estate with associated indebtedness.

The organization will owe tax on these activities.

Then there is the worst-case scenario: the revocation of the tax-exempt status itself. Think Elon Musk putting Tesla in a 501(c)(3) – the IRS is going to blow-up that arrangement.

Let’s discuss a recent case that walked the revocation ledge.

There is an organization in New York. It is open to seniors from age 55 to 90. To become a member a senior must submit an application and application fee. 

It appears to have four principal activities:

·      To provide burial benefits for members and assistance to surviving family

·      To provide information and referrals to seniors regarding burial as well as general concerns

·      To provide organized activities for senior citizens

·      To provide annual scholarships to needy, promising students

The organization charges fees as follows:

·      An application fee of $100 for seniors age 55 to 70

·      An application fee of $150 for seniors age 71 to 90

·      A $30 annual fee

·      A $10 fee every time a member dies

It doesn’t appear unreasonable to me.

There was an interesting and heartwarming twist to their activities: the organization would pay a separate amount directly to the family of a deceased member, pursuant to a Korean tradition. The organization paid, for example, $11 thousand directly to a funeral home and over $3,200 to the family of a deceased member.

Since we are talking about them, you know that the organization went to audit.

The IRS wanted to revoke their tax-exempt status.

Why?

The is an over-arching requirement that a tax-exempt be operated “exclusively” for an exempt purpose. There is some latitude in the “exclusive” requirement, otherwise de minimis and silly stuff could cost an organization its exemption.

Still, what did the IRS see here?

The first is that benefits were available only to members.

COMMENT: The organization had expressed an intent to include nonmembers, but as of the audit year that goal remained aspirational.

OBSERVATION: The organization had told the IRS of its intent to include nonmembers when it requested exempt status. Upon audit and failure to find nonmember benefits, the IRS argued that the organization had failed to operate in the manner it had previously represented to the IRS. 

Second is that a member was required to pay dues. In fact, if a member failed to pay dues for 90 days after receiving written notice, the organization could terminate the membership and – with it – the requirement to pay any burial benefits.

COMMENT: Sounds a bit like an insurance company, doesn’t it?

Third is that the amount of burial benefits was based on the number of years the deceased had been a member. A member of 12 years would receive more than a member of 5 years.

The IRS brought big heat. The organization was organized in 1996, applied for exempt status in 1998 and was being audited for 2013.

OK, a reasonable number of years had passed since receiving exempt status.

The organization had reported over $2.3 million in revenues on their Form 990.

Sounds to me like they were doing well.

In 2008 they bought a condominium, paying over $800 grand.

Oh, oh.

You can begin to understand where the IRS was coming from. As operated, the organization was looking like a small insurance company. It was accumulating a bank balance; it had bought real estate. The IRS wanted to see obvious charitable activities. If the organization could swing $800 grand on a condo, then they could shake loose a few dollars and waive dues for someone who was broke. They were operating dangerously close to a private club. That is fine, but do not ask for (c)(3) status.

The organization had a remaining argument: there was no diversion of earnings or money. There couldn’t be, as no benefits occurred until someone passed away.

The Court however separated this argument into two parts:

(1)  The earnings and assets of the organization cannot inure (that is, return to) to a member.

The organization successfully argued this point.

(2)  There must be no private benefit.

This makes more sense if one flips the wording: there must be a public benefit. The Court did not see a public benefit, as the organization was not providing benefits to nonmembers or allowing for reduction or abatement of dues for financial need. Not seeing a public benefit, the Court saw a private benefit.

The organization was operating in a manner too close to a for-profit business, and it lost its tax-exempt status.

I get the technical issues, but I do not agree as vigorously as the Court that there was that much private benefit here. Society has an interest in promoting the causes and issues of senior citizens, and the organization – in its own way – was helping. By aiding seniors with government agencies, it was reducing the strain on social services. By assisting seniors with planning and paying for funeral services, it was reducing costs otherwise defaulting to the municipality.

One would have preferred a warning, an opportunity for the organization to right its course, so to speak. What happened instead was akin to burning down the bridge.  

Still, that is how issues in this area go: one is working on a spectrum. The advisor has to judge whether one is on the safe or the non-safe side of the spectrum.

The Court decided the organization had wandered too far to the non-safe side.

Our case this time was The Korean-American Senior Mutual Association v Commissioner.

A Failed E-Filed Return Hit With Penalties

 

I have noticed something about electronic filing of tax returns, especially state returns: there is a noticeable creep to demanding more and more information. I can understand if we are discussing tax-significant information, but too often the matter is irrelevant. We received a bounce from Wisconsin, for example, simply because there was a descriptor deep in the state return without an accompanying number.

How did this happen? Perhaps there was a number last year but not one this year. Could an accountant have scrubbed it out? Yes, in the same way that I could have played in the NFL. Work on a return of several hundred pages, add a few states in there for amusement, tighten the screws by closing in on a 15^th deadline and you might miss a description on a line having no effect on the accuracy of the return.

Why is this an issue?

Because if a state – say Wisconsin - bounces a return, then it is the same as never having filed a return. The penalties for not filing a return are more severe than – for example - filing a return but not paying the tax. Does it strike you as a bit absurd for a state to argue that one never filed a return when an accountant prepared (and charged one for) that state return?

The US Tax Court has reviewed the issue of what counts as a federal tax return in a famous case called Beard v Commissioner. The Court looks at four items, each of which has to be met:

·      It must purport to be a return;

·      It must be signed under penalty of perjury;

·      It must contain sufficient information to allow the calculation of the tax; and

·      It must be an honest and reasonable attempt to satisfy the requirements of the tax law.

Let’s look at a case involving the Beard test.

John Spottiswood (let’s call him Mr S) filed a joint 2012 tax return using TurboTax. He made a mistake when entering a dependent’s social security number. He submitted the electronic return through TurboTax on or around April 12. Within a short period, TurboTax sent him an e-mail that the IRS had rejected the return.

Problem: The e-mail was sitting in TurboTax. Mr S needed to log back in to TurboTax to see the e-mail. A professional would know to check, but an ordinary individual might not think of it.

Another Problem: Mr S owed almost $400 grand with the return. Since the return was never accepted, the bank transfer never happened. He did not pay the tax until almost 2 years later.

The IRS tagged him over $40 grand for late payment of tax.

I have no issue with this. Think of the $40 grand as interest.

The IRS also tagged him over $89 grand for late filing of the return.

I have an issue here. Mr S did try to file; the IRS rejected his return. I see a significant difference between someone trying and failing to file a return and someone who simply blew off the responsibility to file. It strikes me as profoundly unfair to equate the two.

Mr S protested the late filing penalty.

He had two arguments:

(1)  He did file (per the Beard standard).

(2)  Failing that, he had reasonable cause to abate the penalty.

I like the first argument. I would advise Mr S to provide a copy of the return to the Court and request Beard.

COMMENT: I suppose the issue is whether the return would meet the third test – sufficient information to calculate the tax. I would argue that it would, as the IRS could deny the dependency exemption and recalculate the tax accordingly. If Mr S objected to the loss of the exemption, he could investigate and correct the social security number.

FURTHER COMMENT: The IRS argued that it could not calculate the tax because it had rejected the return. I consider this argument sophistry, at best. The IRS could simply reject a return ... some returns … all returns … and make the same argument.

But Mr S could not provide a copy of the return.

Why not? Who knows. I suppose he never kept a copy and later lost the username and password to the software.

The Court cut him no slack. To conclude that the return met the Beard standard, the Court had to … you know … look at his return.

That left his second argument: reasonable cause.

The Court again cut him no slack.

The Court said that he should have logged back into TurboTax and yada yada yada.

Seems severe except for one thing: how could Mr S fail to realize that he never got dinged with an almost-$400 thousand bank transfer? I get that he carried a large bank balance, but reasonable people would pay attention when moving $400 grand.

Mr S could not provide a copy of his return nor could he explain how he could blow-off $400 grand. The Court was not buying his jibe.

There was no Beard for Mr S, nor was there reasonable cause to abate the penalty.

OBSERVATION: It occurs to me that Mr S may have received no advantage from the dependency exemption. This case involves a 2012 tax return, and for 2012 it is very possible that the alternative minimum tax (AMT) applied to this return. The AMT serves to disallow selected tax attributes to higher-income taxpayers – attributes such as a dependency exemption (I am not making this up, folks). The Court did not say one way or the other, but I am left wondering if he was penalized for something that did not affect his ultimate tax.

Our case this time was Spottiswood v US.

Abatement Versus Refund

 

I was contacted recently to inquire about my interest in a proceduralist opportunity.

That raises the question: what is a proceduralist?

Think about navigating the IRS: notices, audits, payment plans, innocent spouse claims, liens and so on.  One should include state tax agencies too. During my career, I have seen states become increasingly aggressive. Especially after COVID – and its drain on state coffers - I suspect this trend will only continue.

I refer to procedure as “working the machine.” This is not about planning for a transaction, researching a tax consequence or preparing a tax return. That part is done. You have moved on to something else concerning that tax return.

Less glamorously, it means that I usually get all the notices.

Let’s go procedural this time.

Let’s talk about the difference between an abatement and a refund.

Mr Porporato (Mr P) filed a return for 2009. He owed approximately $10 grand in taxes.

He did not file for 2010 or 2011. The IRS prepared returns for him (called a Substitute Return), and he again owed approximately $10 grand for each year.

COMMENT: He had withholding but he still owed tax for each year. He probably showed have adjusted his withholding, but, then again, he went a couple of years without even filing. I doubt he cared.

The IRS came a-calling for the money, and Mr P requested a Collection Due Process hearing.

COMMENT: I agree, and that is what a CDP hearing is about. Mind you, the IRS wants to hear about payment plans, but at least you have a chance to consolidate the years and work-out a payment schedule.

There was chop in the water that we will not get into, other than Mr P’s claim that he had a refund for 2005 that was being ignored.

So what happened with 2005?

Mr P and his (ex) wife filed a joint 2005 return on June 15, 2006.

Then came a separation, then a divorce, then an innocent spouse claim.

Yeeessshhh.

He amended his 2005 return on March 29, 2010. The amended return changed matters from tax due to a tax overpayment. The IRS abated his 2005 liability.

There you have the first of our key words: abatement.

Let’s review the statute of limitations (SOL). You generally have three years to file a tax return and claim your refund, if any. Go past the three years and the IRS keeps your refund. There are modifiers in there, but that is the general picture. We also know the flip side of the SOL: the IRS has three years to examine your return. Go past three years and the IRS cannot look at that year (again, with modifiers). Why is this? It mostly has to do with administration. Somewhere in there you have to close the matter and move on.

Let’s point out that Mr P amended his 2005 return after more than three years. The IRS still reversed his tax due.

Can the IRS do that?

Yep.

Why?

An IRS can abate at any time. Abatement is not subject to the restrictions of the SOL.

Abatement means that the IRS reducing what it wants to collect from you.

But the result was an overpayment.

Mr P wanted the IRS to refund his 2005 overpayment – more specifically, to refund via application of the overpayment to later tax years with balances due.

This is not the IRS reducing what it wants to collect. This is in fact going the other way: think of it as the IRS writing a check.

Wanting the IRS to write a check ran Mr P full-face into the statute of limitations. He filed the 2005 amended outside the three-year window, meaning that the SOL on the refund was triggered.

I get where Mr P was coming from. The IRS cut him slack on 2005, so he figured he was entitled to the rest of the slack.

He was wrong.

And there you have the procedural difference between an abatement and a refund. The IRS has the authority to reduce the amount it considers due from you, without regard to the SOL. The IRS however does not have the authority to write you a check after the SOL has expired.

Another way to say this is: you left money on the table.

Our case this time was Porporato v Commissioner (TC Summary Opinion 2020-24).