The 'home is where the tax money is' Case

Case: Haggerty

Date: 12/5/11

Case in a nutshell: Taxpayer petitioned for innocent spouse relief when she discovering, after his death, that her late husband had secretly drawn out large amounts from pension funds without adequate withholdings in the year of his death. She filed a joint return because that is what accountant prepared. (He assumed since she had always filed jointly with her husband she would want to continue to do so.) The tax court found against the taxpayer.

Take Aways:

1. Never sign a joint return in a situation such as this. One of the factors is whether the spouse knew or should have known that the tax would not be paid when signing the return. In this case, she absolutely knew because her spouse was dead and she knew she couldn’t pay the tax.
2. The IRS frequently tries to state that being widowed does not equate to being divorced at the time when relief is sought. (One of the 7 factors the courts consider.) The tax courts repeatedly find this neutral.
3. In this case the taxpayer significantly benefited from the income in that her mortgage was paid off using the draws. She could afford to make payments on the taxes with the income she received or she could have borrowed against the house to do so. Whoever advised her to pursue this in tax court gave her bad advice. Case precedents are plentiful and it seems clear that she did not stand a chance. 

The 'you get what you pay for' Case

Case: Dennis


Date: 12/5/11

Case in a Nutshell: The taxpayer failed to report proceeds from a racial discrimination lawsuit because she claimed to have consulted three tax preparers, none of whom told her it was taxable. This was reported on a 1099-MISC. She also failed to report wages because she claimed to not be able to procure a W2 form. The court found against the taxpayer on both counts.

Take Aways

1. You are responsible for paying tax on all income you earn regardless of whether or not the payee remits a W-2 or 1099 form to you. In this day and age it is not difficult for a CPA, with a signed power of attorney, to access your transcript. The current year forms may not be available until July so it may be necessary to file an extension, however, if you have no idea how much you earned and can’t obtain a copy of your W2/1099 this is another way to obtain the info to prepare an accurate return.
2. There are a number of gray areas related to the taxability of lawsuit settlements but this settlement doesn’t fall into any of those areas. Damages in this case were clearly for “loss of self-esteem, humiliation, emotional distress and mental anguish and pain” Petitioner suffered no physical injuries as a result of the harassment. Further petitioner signed a document from her attorneys which stated, among other things: Counsel has further informed Client that payment for non-physical injuries are generally taxable.”
3. The court did not assess the accuracy-related penalty against the lawsuit proceeds portion of under-reported income because she had consulted 3 tax preparers none of whom told her it was taxable. I strongly disagree with this finding. I don’t those preparer’s rise to the level of professionals and therefore I don’t think she took reasonable steps to consult with competent professionals. This is not a complicated issue. Any practicing CPA would have given her the correct info or at least conducted the research to arrive at the correct answer which would have required 30 minutes at most. She should have made an appointment with a CPA as soon as she received the proceeds instead of trying to call around and set the answer for free or on the cheap.
4. Although some independent accountants may be very competent there is no framework in place to compel them to be competent. CPA firms are heavily regulated and reviewed and even chain tax prep services have quality controls imposed at a corporate level by the franchise. Joe’s Accounting & Tax Prep likely just has Joe and he may be way too easy on himself.

The 'that is what you get for thinking' Case

Case: Jones-Place


Date: 12/5/11

Case in a Nutshell: Taxpayer petitioned the court to overturn the IRS rejection of her request for innocent spouse relief. She was jointly liable for taxes due on a return filed with her ex-spouse. The divorce decree designated the debt her ex’s however the IRS was keeping her tax refunds to offset the debt. Her ex was making timely payments on the debt and had reimbursed her for the refunds that were offset. The court found for the taxpayer after examining all the facts and circumstances against the 7 established tests for determining if it would be inequitable to hold the spouse liable.
Take Aways:

1. 1. One of the factors considered in these cases is whether on the date the spouse signed the joint tax return he/she did not know, and had no reason to know, that the taxes would not be paid. The petitioner testified that she thought, since the divorce decree made the debt her ex-husband’s, that the IRS could no longer hold her liable. This is not so. 1) The IRS, like most other creditors, does not care about what your divorce decree says. The decree may give you a legal right to get reimbursed by your spouse if the creditor collects from you. 2) The court was not impressed by this response and actually interpreted it as evidence that she knew her husband would not pay so that point fell against her.

Reliance on professional advice defense to accuracy and gross misstatement penalties

The regulation somewhat unhelpfully states that reliance on professional advice is “reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.”

First, was the adviser a competent professional who had sufficient expertise to justify reliance?

Second, did the taxpayer provide necessary and accurate information to the adviser?

Third, did the taxpayer actually rely in good faith on the adviser’s judgment?

“advice must generally be from a competent and independent advisor unburdened with a conflict of interest and not from promoters of the investment.” “ a promoter is an adviser who participated in structuring the transaction or is otherwise related to, has an interest in, or profits from the transaction.” a tax adviser is not a “promoter” of a transaction when he has a long-term and continual relationship with his client; does not give unsolicited advice regarding the tax shelter; advises only within his field of expertise (and not because of his regular involvement in the transaction being scrutinized); follows his regular course of conduct in rendering his advice; and has no stake in the transaction besides what he bills at his regular hourly rate.

Innocent Spouse – Considerations when threshold but not safe harbor met

A requesting spouse such as petitioner, who satisfies the threshold conditions but fails to satisfy the safe harbor conditions is nevertheless eligible for relief under 6015(f) if, taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable for an underpayment. No single factor is determinative, all factors are to considered and weighed appropriately, and the listing of factors is not intended to be exhaustive.

-Economic hardship for these purposes is defined as the inability to pay reasonable basic living expenses if the requesting spouse is held liable for the tax owed. The ability to pay reasonable basic living expenses is determined by considering among other things the following nonexclusive factors: The taxpayer’s age; employment status; ability to earn; number of dependents; expenses for food, clothing, housing, medical, and transportation; and any extraordinary circumstances.

Those factors are: (1) Marital status; (2) economic hardship; (3) whether the spouse seeking relief knew or had reason to know that the other spouse would not pay the income tax liability; (4) the other spouse’s legal obligation to pay the tax liability; (5) whether the spouse seeking relief obtained a significant benefit from the nonpayment of the tax liability; and (6) whether the spouse seeking relief complied with Federal income tax laws (7)presence of spousal abuse during period when liability was accrued

Innocent Spouse – Safe Harbor Conditions

If the threshold conditions are met, the Commissioner ordinarily will grant equitable relief under section 6015(f) with respect to an underpayment of income tax reported on a joint Federal income tax return, provided ALL the following three safe harbor conditions are satisfied: (i) On the date of the request for relief, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse; (ii) on the date the requesting spouse signed the joint income tax return, the requesting spouse did not know, and had no reason to know, that the nonrequesting spouse would not pay the tax liability; and (iii) the requesting spouse will suffer economic hardship if the Commissioner does not grant relief.

Innocent Spouse – Threshold Conditions

A spouse or former spouse may petition the Commissioner for relief from joint and several liability in certain circumstances.The Commissioner may relieve a spouse or former spouse from joint and several liability if, taking into account all the facts and circumstances, it would be inequitable to hold the taxpayer liable for any unpaid tax or deficiency. Seven threshold conditions must be satisfied before the Commissioner will consider a request for equitable relief

(i) The requesting spouse filed a joint income tax return for the taxable year for which he or she seeks relief;

(ii) relief is not available to the requesting spouse under section 6015(b) or (c);

(iii) the requesting spouse applies for relief no later than 2 years after the date of the Commissioner’s first collection activity after July 22, 1998, with respect to the requesting spouse;3

(iv) no assets were transferred between the spouses as part of a fraudulent scheme by the spouses;

(v) the nonrequesting spouse did not transfer disqualified assets to the requesting spouse;

(vi) the requesting spouse did not file or fail to file the return with fraudulent intent; and

(vii) the Federal income tax liability from which the requesting spouse seeks relief is attributable to an item of the individual with whom the requesting spouse filed the joint income tax return.

Basics for Strict Substantiation Requirements for Vehicle, Travel, and Entertainment Deductions:

To substantiate a deduction attributable to listed property a taxpayer must maintain adequate records or present corroborative evidence to show the following: (1) The amount of the expense;(2) the time and place of use of the listed property; and (3) the business purpose of the use (4) the business relationship to the taxpayer of persons entertained or using the property. A contemporaneous log has a high degree of credibility. The log need not duplicate information on receipts so long as the log and receipts complement each other in an orderly manner. Contemporaneous logs are not required, but corroborative evidence to support a taxpayer’s reconstruction of the elements of an expenditure or use must have “a high degree of probative value to elevate such statement” to the level of credibility of a contemporaneous record

Basics for Courts Prerogative to Approximate Amounts

If a taxpayer establishes that he or she paid or incurred a deductible business expense but does not establish the amount of the expense, the court generally may approximate the amount of the allowable deduction, bearing heavily against the taxpayer whose exactitude is of his or her own making. (Cohan doctrine) However, for this rule to apply, there must be sufficient evidence in the record to provide a basis for the estimate. Certain expenses may not be estimated under the this rule because of the strict substantiation requirements. The expenses to which this rule does not apply include, among other types, expenses for listed property (e.g., automobiles, cellular telephones, computer equipment, or any property of a type generally used for purposes of entertainment, recreation, or amusement) and travel expenses.

Business Deduction Basics

To qualify as a business deduction, “an item must (1) be ‘paid or incurred during the taxable year,’ (2) be for ‘carrying on any trade or business,’(3) be an ‘expense,’ (4) be a ‘necessary’ expense, and (5) be an ‘ordinary’ expense.” An ordinary expense is “of common or frequent occurrence in the type of business involved A necessary expense is appropriate and helpful in carrying on the trade or business however, no portion of the cost of operating an automobile that is attributable to personal use is deductible. Similarly, ordinary commuting expenses are not deductible.