The Tax Court in Brief – May 16th – May 20th, 2022

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.

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Tax Litigation:  The Week of May 16th, 2022, through May 20th, 2022

Caldwell v. Comm’r, T.C. Memo 2022-51 | May 20, 2022 | Lauber, J. | Dkt. No. 3333-19.


Short Summary: Paul Caldwell worked for Sprint Nextel as an account executive. His monthly income was $10,275. Through his employer he enrolled in two disability programs: the “Core Plan” and the “Buy-Up Plan”. These plans provided payment in the event Caldwell was unable to perform the material duties of his employment due to injury or sickness. The Core Plan provided 50% of his monthly income. Sprint paid all premiums under the Core Plan without any contribution from Caldwell. Caldwell paid for the Buy-Up Plan with pre-tax payroll deductions from his Sprint wages. The benefit paid 15% of his monthly salary. After suffering a knee injury, Caldwell applied for his benefits. In 2011 Caldwell received $61,187.62 and $27,204.07 under the Core Plan and Buy-Up Plan, respectively. Caldwell did not file a return for 2011. Through a substitute for return (SFR), the IRS determined that these payments were includible in Caldwell’s gross income. After taking the standard deduction and allowing one personal exemption, the IRS claimed his taxable income was $101,286 with a tax liability of $21,977.

Key Issues:

  • Is Caldwell required to include in gross income the benefits he received from his disability plans?
  • Is Caldwell liable for additions to tax for failure to file and pay?

Primary Holdings:

  • Caldwell had to include in gross income the disability benefits he received because the plans were paid with pre-tax dollars instead of post-tax dollars. Thus, the $88,391 received from his disability plans were properly included by the IRS.
  • The court determined Caldwell liable for additions to tax for failure to file and pay because he did not present credible testimony nor evidence for his failure to file. Moreover, he presented no evidence or testimony on his failure to pay. Therefore, the court determined he was liable for addition to tax assessments.

Key Points of Law:

  • Burden of Proof: The IRS determined in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving them erroneous. Rule 142(a); see Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift if the taxpayer produces credible evidence and has maintained all required records. See 26 U.S.C. § 7491(a)(1), (2)(B).
  • Establishing Unreported Income: 61(a) provides that gross income means all income from whatever source derived. If income is unreported, the IRS must establish an evidentiary basis connecting the taxpayer to the income-producing activity. Weimerskirch v. Comm’r., 596 F.2d 358, 361 (9th Cir. 1979). Alternatively, the IRS may demonstrate that the taxpayer actually received such income. Edwards v. Comm’r., 680 F.2d 1268, 1270–71 (9th Cir. 1982). The IRS sufficiently meets its initial burden of production if he produces a Form W-2. Id. at 1005. This can be rebutted by the taxpayer under § 6201(d). If the IRS relies on third-party reporting, the taxpayer may assert a reasonable dispute and provide the IRS with access to and inspection of all witnesses, information, and documents within the taxpayer’s control. § 6201(d). If not, the taxpayer must prove, beyond a preponderance of the evidence, that the IRS’s determination of unreported income is arbitrary or erroneous.
  • 104 Compensation for Injuries or Sickness: Generally, under § 104(a)(3) gross income does not include amounts received through accident or health insurance for personal injuries or sickness. However, amounts received by an employee that are (1) attributable to contributions by the employer which were not includible in the gross income of the employee or (2) are paid by the employer, are includible in the employee’s gross income. See also Tuka v. Comm’r., 120 T.C. 1, 4 (2003). Thus, as the court states, disability benefits constitute taxable income unless the premiums are paid with after-tax dollars.
  • Additions to Tax.
    • Failure to File: Under § 6651(a)(1) an addition to tax of 5%, of the tax required to be shown on the return for each month for which there is a failure to the return, but not to exceed 25%. The IRS has the burden of production on this point. § 7491(c). If the taxpayer shows that his failure to file was due to reasonable cause and not due to willful neglect, then no addition to tax will apply. § 6651(a)(1).
    • Failure to Pay: 6651(a)(2) provides for an addition to tax when a taxpayer fails to timely pay the tax show on his return. The IRS meets his burden of production for this subsection when he supplies evidence of a return. § 7491(c). Moreover, an SFR which meets the requirements of § 6020(b) is treated as the return filed by the taxpayer. § 6651(g)(2). The tax will not apply if the taxpayer can show a reasonable cause exception.

Insights: This case is a great review of specific types of income-producing activities which result in gross income to the taxpayer under § 61. The case also highlights some of the penalties taxpayers face if he or she has failed to file an income tax return. Additionally, the case sheds light on Tax Court procedural issues. If a taxpayer has received disability for benefits for personal injury or sickness from pre-tax dollars, then the benefits are, more likely than not, properly included in gross income. Therefore, failure to report such income may result in the IRS declaring a deficiency on the return where reporting was required. The taxpayer should keep detailed records of benefits received so that, if a third-party files an erroneous W-2, the taxpayer may then raise a reasonable dispute. If the IRS lodges an addition to tax against the taxpayer, then the taxpayer must do more than saying he did in fact file a return. If the taxpayer supplies no evidence of reasonable cause aside from testimony that he did file a return, then the taxpayer fails to establish a reasonable cause exception. The taxpayer may face an addition to tax for failure to file. Furthermore, the taxpayer will face an addition to tax for failure to pay when the IRS supplies an SFR and subsequently declares a deficiency based on that return.

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