Written on behalf of Feigenbaum Consulting
One of the most important aspects of personal tax planning and compliance is to ensure you provide accurate reports to the Internal Revenue Service if you live in the United States or the Canada Revenue Agency if you live in Canada. Underreporting income can lead to penalties, while overreporting income can lead to having to pay more in tax than you should be required to. In a recent case heard by the United States Tax Court, a taxpayer reported significantly more income than she later claimed she should have. The case serves as a good example of how difficult it can be to undo an error like that as well as how the courts might assess whether an error was made in the first place.
Tax return says $169,882 is due
The matter came before the court as part of a collection due process (CDP) that involved the IRS and a taxpayer. Throughout 2013 the taxpayer worked as an office manager for a law firm in Washington DC specializing in real estate and construction law. She was also a partner in an investment firm (referred to as “Cadillac”) which was engaged in the purchase, leasing, and sale of real property. She held a 33.5% share of its profits, losses, and capital accounts. A partner at the law firm owned the other 66.5% of Cadillac.
In 2013 Cadillac sold the commercial property for $4 million, resulting in a net gain of $3,203,916. Of this gain, the taxpayer claimed on her taxes for that year that she saw a personal gain of $1,073,312. This resulted in $169,882 in taxes owing. She included no payment when submitting her return and indicated she did not have the means to pay it. The amount continued to go unpaid, and by 2016 it had grown to $207,000 as a result of interest and penalties.
Towards the end of 2016, the IRS took measures to seize tax refunds to recoup some of the money owed. The taxpayer requested a CDP hearing, stating she had never received the $1,073,312 she had recorded on her tax return, saying instead that “the sale proceeds were immediately wired to (a bank) and used to pay off the bank credit line of the law firm that I worked for.” She stated she wanted to use the CDP hearing to clear this up.
A series of CDP hearings
At the initial CDP hearing, the settlement officer told the taxpayer that alternative collection measures could not be considered because no financial information beyond her tax return had been provided. The taxpayer eventually appealed this decision, and a supplemental hearing was scheduled.
The second CDP hearing took place in June 2018. The taxpayer was reminded that the taxes she owed were the result of her own reporting. She was asked to file an amended tax return but failed to do so. As a result, the settlement officer closed the case.
Following this, the taxpayer took the issue to the United States Tax Court. At first, the settlement officer asked for a summary judgment to deny the motion based on the taxpayer’s failure to provide a supplemental tax return. However, the court decided to send the matter to yet another supplemental hearing, stating that the settlement officer had acted unreasonably in not trying to determine how much tax was owed.
A new settlement officer was assigned, and a hearing was set for October 2019. This time the taxpayer brought forth documentation laying out her position. It turned out that Cadillac had a loan with a bank. The terms of the loan stipulated that if Cadillac were to sell any of the collateral securing the loan (including the property it sold in 2013) then the repayment of the loan would be accelerated. This was why the proceeds from the sale were immediately transferred out of the taxpayer’s accounts. Despite this, the settlement officer concluded that she had “constructively received” the $1,073,312 she had reported on her tax return. The settlement officer also concluded that she was in a position to fully pay her 2013 tax liability.
Following that hearing, the settlement officer proposed a repayment plan calling for monthly payments of $3,483. The taxpayer asked for time to see if she could have the law firm she works for assist with this, but did not ever get back to the settlement officer. As a result, the case was closed, and the IRS initiated a collection action.
The matter was returned to the United States Tax Court with the parties asking for a decision without trial. Once again, the taxpayer did not file any material for the courts to review.
Challenging tax liability
The court found that the documentation provided by the taxpayer confirmed she was a partner in Cadillac and that she owned a 33.5% share of its profits, losses, and capital. This means the income she reported in her 2013 tax return was accurate even if she quickly used the money to pay back a loan.
The United States tax code Section 702(a) stipulates that each partner is taxable on their “distributive share” of partnership income. This is regardless of whether the partner receives the income via distribution or otherwise, meaning that even if the money the taxpayer made from the sale went directly towards the repayment of a loan, the money was still income for tax purposes.
The court concluded that the taxpayer was required to include the income from the sale of the property in her 2013 tax return, noting again that she failed to offer any additional information to aid in her defense to the addition of the income or her failure to pay. The court also found no abuse of discretion by the settlement officers assigned to the case and allowed the collection actions to continue.
Feigenbaum Law assists clients with personal and corporate tax compliance
In addition to helping individuals with their tax compliance, the tax team at Feigenbaum Law also helps corporations in the United States and Canada with tax planning and compliance. Contact us for information on how we can help you reduce your overall tax burden, shield your business from liabilities and avoid pitfalls that result from improper tax planning. We can be reached online or by phone at 877-275-4792.