The Tax Court in Brief
Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.
The Week of March 15 – March 19, 2021
Catania v. Commissioner, T.C. Memo. 2021-33 | March 15, 2021 | Vasquez, J. | Dkt. No. 13332-19
Petitioner worked for Home Depot and participated in its section 401(k) plan. In 2014 he retired from Home Depot and transferred his section 401(k) plan account balance to a traditional individual retirement account (IRA) held at Vanguard Fiduciary Trust Co. (Vanguard). Petitioner was 55 years old at that time.
In 2016 petitioner withdrew $37,000 from his Vanguard IRA. Petitioner used the funds to pay for the maintenance of his home and other necessary living expenses. Petitioner was 57 years old as of December 31, 2016.
Vanguard issued to petitioner Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit- Sharing Plans, IRAs, Insurance Contracts, etc., for 2016 reflecting the distribution. Petitioner reported the Vanguard distribution on his 2016 Federal income tax return. While petitioner included the distribution as income on his return, he did not include the 10% additional tax pursuant to section 72(t)(1) .
- Whether petitioner is liable for the 10% additional tax pursuant to section 72(t)(1)?
- The Tax Court sustained respondent’s determination that petitioner is liable for the additional tax under section 72(t)(1) .
Key Points of Law:
- Section 72(t)(1) imposes an additional tax of 10% on distributions from qualified retirement plans unless one of the exceptions set forth in section 72(t)(2) applies.
- Section 72(t) provides in pertinent part as follows: SEC. 72(t). 10-Percent Additional Tax on Early Distributions from Qualified Retirement Plans.—
(1) Imposition of additional tax.–If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c) ), the taxpayer’s tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.
(2) Subsection not to apply to certain distributions.–Except as provided in paragraphs (3) and (4), paragraph (1) shall not apply to any of the following distributions:
(A) In general.–Distributions which are–
(i) made on or after the date on which the employee attains age 591/2,
* * * *
(v) made to an employee after separation from service after attainment of age 55 * * *
- Because the section 72(t) additional tax is a “tax” and not a “penalty, addition to tax, or additional amount” within the meaning of section 7491(c) , the burden of production with respect to the additional tax remains on petitioner.
- There is no authority in the Code or caselaw for an equitable or hardship exception to the imposition of additional tax under section 72(t) on early distributions from a retirement account.
- The Tax Court is not a court of equity, and we cannot ignore the law to achieve an equitable end.
Insight: The case demonstrates the limited exceptions for the 10% early-withdrawal penalty under section 72(t), and the fact that there is not a general equitable or hardship exception to the penalty. It also serves as a reminder that the Tax Court is not a court of equity.
Siebert v. Commissioner of Internal Revenue | T.C. Memo. 2021-34 | March 15, 2021 | Jones, J. | Dkt. No. 25685-15L
The case arose from a collection due process (CDP) case petitioners seek review pursuant to section 6330(d)(1) of a determination by the Office of Appeals (Appeals or Appeal Office) of the Internal Revenue Service (IRS) to proceed with a proposed levy action to collect their unpaid Federal income tax liability for the 2013 tax year.
Mr. Siebert is an attorney who ran his own law practice. Both petitioners are business owners. Mrs. Siebert is the sole member of Siebert Consulting, and Mr. Siebert is the owner of Siebert Corp. Petitioners timely filed (with an extension) their 2013 tax return, and the IRS assessed the resulting liability, which petitioners did not pay upon notice and demand.
On April 27, 2015, the IRS sent petitioners a Notice CP90, Notice of Intent to Seize Your Assets and Notice of Your Right to a Hearing. On May 27, 2015, the IRS timely received petitioners’ Form 12153, Request for a Collection Due Process or Equivalent Hearing. Petitioners indicated they wished to obtain a collection alternative of an offer-in-compromise (OIC), an installment agreement (IA), or currently not collectible (CNC) status.
Petitioners’ submitted an OIC that proposed to compromise their unpaid tax liabilities for the 2013 tax year as well as the 2001, 2003-05, 2008-12, and 2015 tax years (which at that time totaled approximately $645,314).
Petitioners proposed to settle their total outstanding tax liability of $645,314 with a lump-sum payment of $12, 443. Petitioners enclosed a $2,489 check at the time of submission, representing a 20% down payment, with the remaining balance payable within five months of acceptance. Petitioners premised their OIC on doubt as to collectibility.
The revenue officer (RO) observed that Mr. Siebert had sold his partnership interest for $171,546 in 2015 and that the proceeds from the sale of the partnership interest were not used to pay petitioners’ outstanding tax liability. The RO also remarked that petitioners had previously agreed to use the proceeds from a section 401(k) account (section 401(k) account) to pay a portion of their outstanding tax liability. He determined that in 2015 petitioners had dissolved the section 401(k) account with a value of $151,000, yet the IRS did not receive any payments from the proceeds. The RO noted that petitioners did not report the income from the liquidation of the section 401(k) account on their 2015 tax return.
The RO determined that petitioners had $345,880 of assets that could be used to pay their outstanding tax liability. He calculated that petitioners’ RCP was $2,012,380. He concluded that petitioners’ RCP was full payment of their outstanding tax liability and recommended rejection of their OIC as not in the best interest of the Government.
The RO explained his reasoning in a narrative report. Specifically, the offer specialist indicated that petitioners had “an egregious history of noncompliance” spanning 15 years and neglected to pay their tax debts even when they had the means to do so. The RO also considered that petitioners had a large outstanding tax liability. Citing Internal Revenue Manual (IRM) pt. 22.214.171.124.1(3) (Oct. 7, 2016), he observed that petitioners had failed to pay Federal income tax for the last eight consecutive years. He also observed that during the years of petitioners’ noncompliance, they lived in a home valued at $4 million and paid large expenses associated with their lifestyle.
Appeals concurred with the OIC unit that petitioners’ OIC should be rejected because it was not in the best interest of the Government. This decision was based on: (1) petitioners’ “egregious compliance history”; (2) petitioners’ high income and commensurate lifestyle; combined with (3) petitioners’ failure to turn over funds that would have been available to pay delinquent tax. Appeals repeated the observation that petitioners’ noncompliance spanned 15 years, including the last 8 consecutive years in which they had not paid Federal income tax. Appeals also noted that petitioners’ outstanding tax liability when they submitted their OIC was $645,314. Appeals stated in the supplemental notice of determination that petitioners were high-income earners who enjoyed a commensurate lifestyle during the period in which their tax was not paid, yet they neglected to pay tax even when they possessed the means to do so. In the notice, Appeals reviewed the prior instances in which the IRS had reached agreements with petitioners for payment of their tax liabilities but did not receive payment.
- Whether the IRS Appeals officer abused her discretion in rejecting the taxpayers’ Offer in Compromise (OIC) and in sustaining the IRS’s proposed levy against the taxpayers’ assets.
- The conclude that the settlement officer did not abuse her discretion in sustaining the proposed collection action.
- The Tax Court concluded that SO Walsh did not abuse her discretion in sustaining the rejections of petitioners’ OIC as not being in the best interest of the Government.
Key Points of Law:
- In considering a taxpayer’s qualification for a collection alternative, such as an IA, a settlement officer does not abuse her discretion by relying on guidelines set forth in the IRM.
- In reviewing the settlement officer’s determinations for abuse of discretion, we consider whether she: (1) properly verified that the requirements of applicable law or administrative procedure have been met, (2) considered any relevant issues petitioners raised, and (3) considered whether any proposed collection action balances the Government’s need for the efficient collection of taxes with petitioners’ legitimate concern that any collection action be no more intrusive than necessary.
- The Secretary can compromise an outstanding tax liability on three grounds: (1) doubt as to liability, (2) doubt as to collectibility, or (3) the promotion [*8] of effective tax administration.
- Generally, an OIC based on doubt as to collectibility will be accepted if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the IRS could obtain through other means.
- Generally, the Commissioner will reject an offer based on doubt as to collectibility when the taxpayer’s RCP exceeds the amount he proposes to pay, absent a showing of special circumstances.
- The Commissioner may reject an OIC as not being in the best interest of the Government in certain circumstances.
- The IRS may consider public policy and tax administration concerns when evaluating whether an offer is acceptable.
- Rejection of an OIC as not in the best interest of the Government is not an abuse of discretion if Appeals has considered all of the facts and circumstances of the case and its reasoning is thoroughly explained in the notice of determination.
- The IRM defines the calculation of future income as an estimate of the taxpayer’s ability to pay based on an analysis of gross income less necessary living expenses for a specific number of months into the future.
- If a taxpayer is unemployed for a long period, then the offer specialist should not average the income.
- But, “[i]f there is a verified expectation the taxpayer will be securing employment then the use of anticipated future income may be appropriate. Anticipated future income should not be used in situations where the future employment is uncertain.”
- If a taxpayer has a fluctuating income, then the offer specialist should use the average earnings over the prior three years to calculate future income.
- The offer specialist should generally use the three-year average except when specific circumstances are present.
- Although the IRM does not have the force of law, a settlement officer does not abuse his discretion if he follows the guidelines set forth in the IRM.
- Inclusion of a dissipated asset as part of the RCP determination is not automatic, and such inclusion must be clearly justified in the case activity records If taxpayers can substantiate the claim that the dissipated assets were necessary for the production of income or the health and welfare of taxpayers or their family, those assets should not be included in the calculation of RCP.
- The offer specialist generally considers a three-year look-back period, including the year in which the offer was submitted, to determine whether it is appropriate to include a dissipated asset in the calculation of RCP.
- The taxpayer must be able to provide a reasonable accounting of the dissipated asset.
- Under section 6159 , if a taxpayer cannot timely pay the full amount of tax due, Appeals may allow the taxpayer to pay the tax in installments if Appeals determines that such an agreement will facilitate full or partial collection of the liability. The discretion to accept or reject a taxpayer’s IA lies within the discretion of the Commissioner.
- Under the IRM, an account should not be placed in CNC status if the taxpayer has income or equity in assets and enforced collection of the income or assets would not cause hardship.
- A settlement officer calculates a taxpayer’s ability to make payments by determining the excess of income over necessary living expenses.
Insight: The case provides an excellent background and summary of the Internal Revenue Manual provisions relevant to determining a taxpayer’s financial status and eligibility for various collection alternatives, such as an offer in compromise. The case also serves as a reminder that the IRM does not provide legal rights to a taxpayer, but that an IRS appeals officer does not abuse their discretion by relying upon the relevant IRM provisions.
Latessa Ward v. Comm’r; Ward & Ward Company v. Comm’r, T.C. Memo 2021-32 March 15, 2021 | Holmes, J. | Dkt. No. 29568-15, 29569-15.
Short Summary: The case discusses the substantiation of expenses by a sole shareholder of an S-corporation and the inaccurate reporting of income earned through such entity.
Latessa Ward (the taxpayer) is an attorney that opened her own firm, Ward & Ward Company (the firm) in 2006. She organized her firm as an S-corporation. During 2011, 2012 and 2013 the firm reported on its Form 1120S certain losses, officer compensation and wages. The firm also reported employee compensation on its Form 941.
On her personal tax return for 2011, the taxpayer reported the amount of loss as showed by the firm. However, the taxpayer did not report wages or salaries. Additionally, she incorrectly reported the firm´s income and expenses on her Schedule C and not the applicable Schedule E. Finally, during 2012 and 2013, the taxpayer had some debt discharged.
Because the firm´s 1120S and the taxpayer´s 1040 did not matched, the IRS audited both returns. The controversy focused on the firm´s return (1120S) to determine whether it correctly reported employment taxes on the compensation paid to the taxpayer as an officer of the S-corporation. Additionally, the IRS contested certain expenses such as travel expenses incurred while ¨schmoozing a client¨, contractor expenses, office groceries and membership expenses. In all these cases, the Court ruled that the taxpayer did fail to substantiate the business purpose of each expense, and it rejected them.
As for the taxpayer 1040, the IRS focused on the appropriate reporting of the income earned through the S-corporation, which the taxpayer claimed it was a distribution. The IRS also argued that the compensation received by the taxpayer as an officer was not reported by her. Finally, the taxpayer did not report the discharge of debt occurred during 2012 and 2013, claiming that she was insolvent at that time. In all these items, the Court ruled in favor of the IRS, mainly because the taxpayer failed to provide proper documents to support the expenses.
- Proper documentation to support a business expense.
- Whether an individual has to report the income obtained during the taxable year through an S-corporation in her personal income tax return.
- Whether compensation paid by the corporation to an officer constitutes distributions from the corporation´s earnings and profits.
- The taxpayer has the burden of proof to substantiate the business purpose for each expense.
- Moreover, an individual must report the income obtained from an S-corporation during a taxable year because such income is not a distribution.
- Finally, compensation paid by a corporation to an officer constitutes income and not a distribution, and consequently is subject to self-employment taxation.
Key Points of Law:
- An S-corporation is a pass-through entity, which means that income and expenses obtained by such entity ¨flow-through¨ to the owners of such entity. The S-corporation must file a Form 1120S to properly report the income and expenses incurred throughout its taxable year. Accordingly, the owners of the S-corporation must report on their personal tax return their respective share of such income and expenses. Such reporting is made on Schedule E, Supplemental Income and Loss.
- The S-corporation may also pay proper compensation to its employees-owners. Such compensation is subject to self-employment taxes. The employee-owner must report such income as wages on her personal tax return.
The analysis of the Court for each of the items in controversy is as follows:
- In this case, the S-corporation failed to pay self-employment taxes on the wages paid to the taxpayer as an officer of the firm. See Section. 3121(d)(1). The firm is liable for employment taxes on such wages. Section 530 of the Revenue Act of 1978 offers relief from liability in cases like this, however, the firm must evidence that it consistently did not treat the individual as an employee unless the firm had no reasonable basis for not treating the individual as an employee. In this case, this exception is not applicable because the firm had reasonable basis to treat the taxpayer as an employee, because she was an officer of the corporation.
- Travel expenses. The Court rejected the expenses because the firm failed to substantiate the business purpose of the travel, which usually is done by maintaining a log, or similar documentary evidence. See Section 1.274-5T(c)(2). In this case, the firm only provided bank statements which do not show the business purpose of the expense.
- Office max expenses. Claimed by the firm for supplies and products, the Court allowed these expenses considering the taxpayer´s testimony that she ¨does not show there for personal items¨.
- Office groceries. The Court rejected such expenses because those are personal in nature, and without proper receipts, there is no evidence to show the business purpose.
- As for other expenses such as membership and insurance expenditures, the Court only relied on documents provided by the taxpayer, and mostly rejected them because of lack of proper documentation.
As for the taxpayer’s tax return, the Court ruled on three points:
- Flowthrough income from the S-corporation. The taxpayer claimed that income earned was a tax-free distribution up to the amount of her basis. The Court clarified that income from the firm is not the same as a distribution from the firm. See Section 1366(a). This means that the income that is earned by the corporation during the taxable year is taxable and must be reported by the owner. Distributions, on the other side, are capital that is removed by the owners from the corporations. See Rogers v. Commissioner, 102 T.C.M. (CCH) 536.
- Considering that the Court ruled that the taxpayer was an employee of the firm, the compensation received as an officer constitute wages.
- Cancellation of debt. Debt discharge constitutes income to the debtor. See Section 61(a)(12). An exception to such rule applies when the taxpayer is insolvent. See Section 108(a)(1)(B). The taxpayer must provide evidence to support her insolvency immediately before the debt is discharged. See Shepherd v. Commissioner, 104 T.C.M. (CCH) 108 (2012). In this case, the taxpayer did not provide proper documentation to evidence her insolvency and the Court ruled that the insolvency exception was not applicable.
Insight: A common problem with S-corporations is the proper reporting of the income earned by the entity and the consequent reporting of such income by the taxpayer. This case shows the common misconceptions of the taxpayers when using these types of structures. Although not especially relevant, the taxpayers also must be aware that the proper reporting of the income earned by the S-corporations must be reported on their personal tax returns on Schedule E and not C as happened in this case.