Tuesday’s Young v. IRS, T.C. Memo. 2015-18 (Feb. 2, 2015) demonstrates the consequences before the Tax Court when a tax preparer (who ostensibly understands the code) fails to reply to an IRS petition alleging deficiencies in tax. There, Ms. Young also failed to oppose the motion for summary judgment, which ultimately led to her defeat before the Court. What’s more, the IRS’s case for fraud and the associated 75% penalties became a slam dunk. See page 12 to the end.
Mottahedeh v. IRS, T.C. Memo. 2014-258 (Dec. 29, 2014) perfectly demonstrates the importance of finding a competent, ethical legal advisor. There, the litigants earned a decent living by selling questionable tax planning and reporting advice. That is, they advised dealing in cash, avoiding the paper trail, and refusing to deal with the IRS and California tax authorities. They even offered courses and packages through their “Freedom Law School” in which they taught such strategies.
This factual scenario (in which incompetent tax advisors are facing IRS scrutiny and losing before the Tax Court with their own advice) is actually rather common in Tax Court cases. They illustrate the importance of finding a competent, qualified, and ethical advisor to assist with a taxpayer’s planning and reporting needs. Common indicators include patience, extensive training, a license to practice, and (more than anything else) common sense. No degree certificate or badge of recognition can guarantee such quality, which is why good help is so hard to find. But be sure that if your tax professional’s advice sounds too good to be true, it probably is.
The first case of 2014, Adeyemo v. IRS, was a good reminder that “Rental activity (including rental real-estate activity) is per se passive unless the taxpayer qualifies as a real-estate professional as defined in section 469(c)(7)(B).” Id. at p. 13. For those of you who moonlight as landlords (less than 750 hours a year), be careful when claiming more deductions than earnings for your realty business activities–your passive activity losses can only be deducted to the extent of your passive activity gains. Generally, IRC Sec. 469.
Earlier in January, the Tax Court published a case in which the pro se litigant succeeded in convincing the judge that he was a completely unreliable witness when testifying about his own case: “We found Mr. Sodipo’s testimony to be in certain material respects general, conclusory, vague, uncorroborated, self-serving, and/or not credible. We shall not rely on the testimony of Mr. Sodipo to establish his position with respect to each of the issues that remain for decision.” Sodipo at page 11. To make matters worse, the Court found the opposite to be true with respect to the IRS’s agent: “We found the testimony of the revenue agent to be trustworthy. We shall rely on that testimony as we deem appropriate.” Note, Mr. Sodipo was representing himself, so there was absolutely no one on his side of the case that the Court would believe. This is never a reaction from a Tax Court judge (or any judge for that matter) one hopes to evoke.
Most taxpayers are probably unaware that the Internal Revenue Code (Sec. 104 and 105) allows a taxpayer to exclude money received as compensation for personal physical injury or sickness. That means that the IRS will not tax a person on money he or she is paid to compensate for physical damage suffered due to something like a car accident. Seefacts of IRS v. Schleier, 515 U.S. 323 (1995). Consequently, there have been attempts to construe taxable money as this non-taxable compensation for injury to avoid paying taxes.
The Perez case is a good example of a very recent attempt to do so. According to the court, Ms. Perez received large sums of money in exchange for undergoing procedures to donate her eggs to infertile couples. Pursuant to Ms. Perez’s contracts, the sums she received were designated compensation for “pain and suffering.” Consequently, she did not report these amounts on her 2009 tax return. When the IRS reviewed her returns, it decided to issue a notice of deficiency based what the IRS argued was an improper claim for this tax benefit. To cut to the chase, the Tax Court held that “compensation for pain and suffering resulting from the consensual performance of a service contract is not “damages” under I.R.C. section 104(a)(2) and must be included in gross income.”
This case not only demonstrates a very recent factual scenario in which claiming this benefit is improper, it also exemplifies the way in which a tax benefit should be researched and understood before attempting to claim it on a 1040. A competent tax advisor would have advised Ms. Perez against excluding this income from line 22 of her 1040.
Ferm v. IRS, T.C. Summary Op. 2014-115 (Dec. 30, 2014).
The Tax Court case of Ferm v. IRS demonstrates the old adage that “timing is everything.” There, the cash-method taxpayer (money is earned as it’s actually received, expended as it’s actually paid) paid tuition for Spring 2011 semester on December 28, 2010. Following this payment, the Ferms attempted to deduct their qualified tuition expenses on their 2011 tax return. Like most lay individuals, these taxpayers probably assumed that the expenses were incurred for 2011, so their deduction should be taken that year. However, cash-method taxpayers (which all of us are) may only take deductions for expenditures in tax years when that money was actually paid. This is true regardless of when the benefits from that debt are actually received. Unfortunately for the Ferms, only about $150 of the qualified expenses were actually paid in 2010. If these expenses had been paid four days later, the deduction would have been proper on the 2011 return. See Ferm at p. 9. This “harsh result” perfectly demonstrates that, when it comes to individual income taxes, “timing is everything.”
Yesterday’s Tax Court provided decent analysis on what constitutes a “written separation agreement” to qualify for alimony deductions under Sections 71 and 215 of the IRC.
“Section 71(b)(1) provides:
(1) In general.–The term “alimony or separate maintenance payment” means any payment in cash if–
(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,
(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in
gross income under this section and not allowable as a deduction under section 215,
(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance,
the payee spouse and the payor spouse are not members of the same household at the time such payment is made, and
(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no
liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee
spouse.”
Milbourn at page 8.
Here, the “written separation” element was at issue. The Tax Court reviewed precedent on what might constitute this element.
“The term “written separation agreement” is not defined in the Code, the applicable regulations, or in the legislative history. Leventhal v. Commissioner, T.C. Memo. 2000-92, 2000 Tax Ct. Memo LEXIS 106, at *19 (citing Jacklin v. Commissioner, 79 T.C. 340, 346 (1982)); Greenfield v. Commissioner, T.C. Memo. 1978-386, 1978 Tax Ct. Memo LEXIS 132, at *4-*5. A written separation agreement has been interpreted to require a clear statement in written form memorializing the terms of support between the parties. Jacklin v. Commissioner, 79 T.C. at 348; Bogard v. Commissioner, 59 T.C. 97, 101 (1972). While an oral agreement does not qualify as a written separation agreement, an oral agreement in court which is recorded in a written, official transcript does qualify. Prince v. Commissioner, 66 T.C. 1058, 1066-1067 (1976). A separation agreement requires mutual assent of the parties. Kronish v. Commissioner, 90 T.C. 684, 693 (1988). Letters which do not show a meeting of the minds between the parties cannot collectively constitute a written separation agreement. See Grant v. Commissioner, 84 T.C. 809, 822-823 (1985), aff’d without published opinion, 800 F.2d 260 (4th Cir. 1986); Estate of Hill v. Commissioner, 59 T.C. 846, 857 (1973). However, where one spouse assents in writing to a letter proposal of support by the other spouse, a valid written separation agreement has been held to exist. Leventhal v. Commissioner, 2000 Tax Ct. Memo . . . ”
Milbourn at pages 10-11.
So, if you’re planning to deduct alimony payments on this year’s tax filings, review this list of what has been determined to qualify as a “written separation agreement” to make sure a deficiency is not assessed on your 1040.
The Tax Court issued an MLK-Day gift to the Foreign Service Community with the publication of the Evans v. IRS case. There, the Foreign Earned Income exclusion (IRC Sec. 911) is explained, discussed with other cases, and applied to the facts of Mr. Evans’ case.
“[The Foreign Earned Income exclusion law] provides that a “qualified individual” may elect to exclude from gross income, subject to limitations set forth in subsection (b)(2) [of IRC Sec. 911], his or her “foreign earned income.” To be entitled to this exclusion, a taxpayer must satisfy two distinct requirements. First, he must be an individual “whose tax home is in a foreign country.” Sec. 911(d)(1). Second, he must either be a “bona fide resident” of one or more foreign countries or be physically present in such country or countries during at least 330 days in a 12-month period.”
Evans at page 8.
The Court determined Mr. Evans was not entitled to the exclusion because, in part:
Mr. Evans “was not and could not be joined by his family [abroad in Russia]; slept in employer-provided housing; ate employer-provided meals while on offshore drilling platforms; returned home to the United States during most off-duty periods; had the costs of his travel to and from the United States paid by his employer; and was “essentially commuting on a regular basis from * * * [his] home[] in the United States.”
The Banister case is another good example of the dangers of pro se tax denial before the IRS and Tax Court. Nevertheless, Mr. Banister may have a decent basis on which to challenge the court’s extra civil fine against him for tax fraud under IRC Sec. 6651(f).SeeBanister page 12. That is, the Court decided the IRS had carried its burden (IRC Sec. 7454(a)) of proving that Mr. Banister’s persistent refusal to pay taxes constituted civil fraud by “clear and convincing evidence.” Internal Revenue Manual Sec. 25.1.6. “Clear and convincing” is “that measure or degree of proof which will produce in the mind of the [judge] a firm belief or conviction as to the allegations sought to be established.” Ohio v. Akron Center for Reproductive Health, 497 U.S. 502, 516 (1990).
The evidence supporting this fraud finding was that Mr. Bannister was a professional accountant who had earned a degree in the field and worked for the IRS for a number of years. Further, “Because petitioner refused to testify, he has shown no plausible nonfraudulent explanation for his behavior.” Banister at page 12. Sounds to me like the Court was frustrated with Mr. Banister’s persistent irrationality. In rendering this portion of the decision against Banister, the court ignored conventional definitions of fraud in order to punish Mr. Banister by shifting the burden of proof to him and accepting a lower level of proof (perhaps a preponderance ?) from the IRS.
The case of Becker v. IRS(Jan. 13, 2015), perfectly demonstrates the possible consequences of improperly taking a deduction. Here, much like the example used in Tax Deductions, a Matter of Legislative Grace, the taxpayer improperly claimed is IRC Section 215 (Form 1040 line 31a) alimony payment deductions. See Becker p. 4. Mr. Becker’s precise problem was that in 2011, he underpaid his alimony, paid his child support correctly, but failed to reduce his alimony deductions by the amount he had shorted his ex as required by IRC Sec. 71(c)(3). Consequently, the IRS assess the deficiency and took Mr. Becker to Tax Court when he failed/refused to pay the difference.
The reader might also notice the timing involved with disputes that make it before the Tax Court. The taxpayer here, Becker, made these alimony payments in 2011, filed in 2012, and did not have this dispute resolved by the Tax Court until 2015. Proper planning would have helped him avoid a four-year long struggle that followed his divorce litigation.
Tuesday’s Young v. IRS, T.C. Memo. 2015-18 (Feb. 2, 2015) demonstrates the consequences before the Tax Court when a tax preparer (who ostensibly understands the code) fails to reply to an IRS petition alleging deficiencies in tax. There, Ms. Young also failed to oppose the motion for summary judgment, which ultimately led to her defeat before the Court. What’s more, the IRS’s case for fraud and the associated 75% penalties became a slam dunk. See page 12 to the end.
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