Tuesday, May 10, 2022

So, You Think That You Are Entitled to Claim Itemized Deducitons?

William Delaney, EA
Westwood, MA

Just want you need to see walking into your office right after a tough tax season. A taxpayer who is a few years behind in filing his income tax returns, and he is here because he has been caught by the IRS. Consider the plight of Shawn Stephen Salter, who had not filed for tax year 2013 and, of course, ignored IRS notices/correspondence from a time (pre-COVID) when the IRS was still able to function properly.

Eventually, the IRS prepared a substitute return and they had a lot of gross income information available (W-2 wages; unemployment compensation; dividends; taxable state refund; capital gains; taxable retirement income. Did I leave anything out---oh, yes, there was also some “other” income). The IRS “generously” allowed a personal exemption and the standard deduction. The tax, interest, and various penalties were calculated and billed. That got the attention of the taxpayer, who decided to be a bit creative…

“After receiving the notice of deficiency, petitioner (taxpayer) informed the IRS of his belief that he had filed a return for 2013 using H&R Block software. But, IRS records showed that no return had been submitted, and the petitioner was unable to produce, from H&R Block or his own files, a copy of a return or evidence of it filing.” Shawn Stephen Salter v. Comm., TC Memo 2022-29 (4/5/2022). Oh, did I forget to mention that this purported to be a refund return, yet the IRS had no record of a refund nor could the taxpayer show that he had received and deposited same.

When that didn’t work, the taxpayer then prepared a form 1040 and reported all of the income shown on the substitute return. He also claimed itemized deductions. Your Editor, and I assume this to be true of others, has been successful in convincing the IRS to accept an original 1040 in place of a substitute return and assess accordingly, but this isn’t always the case…

The IRS received the return and decided to audit the itemized deductions. They could match state and local taxes, home mortgage interest, and mortgage insurance premiums. So far, so good. However, “Petitioner supplied no documentation, during IRS examination or at trial, to substantiate the other deductions he claimed, and he admitted that he had estimated these amounts.” Ibid., page 3.

As a result of the failed audit, the IRS refused to accept the form 1040 for filing. And, they may do just that, since §6020(a) allows them to prepare “a return required by this title” and (b)((2) states that such a return “…shall be prima facie good and sufficient for all legal purposes.” So, they already had a legally filed return and were not obliged to accept the taxpayer’s much later and very flawed submission. Now, for the really fun part. It turns out that the IRS didn’t need an audit; they could have denied all of the itemized deductions because the taxpayer had not made a timely election to itemize.

Your Editor had always assumed that itemized deductions is an available option when filing an original (not an amended) income tax return. Well, according to the Tax Court, this isn’t so…

“Section 63(e)(1) provides that ‘…unless an individual makes an election under this subsection for the taxable year, no itemized deduction shall be allowed for the taxable year’.” But, didn’t the taxpayer file a return (although it was late) and elect itemized deductions? The Tax Court cited (among several authorities) George v. Comm., TC Memo 2019-128 – “Thus, if an individual fails to file a return, he has made no election to itemize his deductions.” If no return is filed and “…as a result, the Commissioner prepares a substitute return, then the individual has made no election and may not claim itemized deductions.”

What is our taxpayer to do? He decided to continue to do it himself and filed a pro se petition with the Tax Court. This means, he decided to represent himself without the need for counsel. He then proceeded to prove the validity of the adage (slightly amended by your Editor) – a taxpayer who represents himself has a fool for a client (attributed to Abraham Lincoln).

The Court (not surprisingly) determined (page 5) “…petitioner did not file a return for 2013, that he made no election to itemize deductions as required by section 63(e), and that he accordingly is not allowed any itemized deductions. He remains entitled to the standard deduction as calculated on the notice of deficiency.”

A one-page summary of this case in TheTaxBook News states that the taxpayer “filed an amended return claiming itemized deductions.” This appears to be an incorrect reading of the fact pattern; the rejected 1040 was an original filing, and the decision of the Court centers on an attempt by the taxpayer to override a substitute return by filing an original return (which probably would have been accepted had it not failed the audit examination).

It turns out that Abraham Lincoln was spot on!

Friday, February 18, 2022

MA Paid Family & Medical Leave Taxation Issues


Now that a few months have passed and this new tax has been deducted and/or

employer only paid, have we handled it correctly? What’s to handle, you might ask?

I haven’t seen anyone draw down on this fund (with good reason---it’s too soon for

benefits to kick-in). Yes, but is it taxable when it does suddenly appear in a subsequent

year – or currently for a RI resident (more on this later).


What about the employee payroll deductions? If you are like me, at least half of the

W-2 forms which should have shown something in box #14 did not have an entry. If

there is an entry, did you do anything with it? It qualifies as a SALT (state and local

[income] tax) so it should be posted to Schedule A---subject to the $10,000 annual

limitation. For authority, see CCA 200630017 (7/28/2006).

Is it taxable income when received. YES, according to the Chief Counsel’s Advice cited

above. If you received an itemized deduction for the employee payment, the entire

benefit is taxable when received. If you were unable to itemize, the amount of the

payroll deduction becomes your tax basis and it is excluded from taxable benefit

income.


While this is the federal rule for the Massachusetts and Rhode Island State plans, other

state plans may be treated differently.


And, if you have not forgotten, the RI “tax” qualifies as a state tax when computing the

maximum amount of credit on the MA resident return for taxes paid to another state.

See MA Revised Directive 12-1 (3/15/12). Does RI reciprocate? Not at this time. The

regulation in effect since 1/1/1998 is PIT 98-12 and it specifies (see part IV) that the

allowable state income tax must be similar to what is allowed on the RI personal income

tax return. The RI personal return only allows (Schedule W) a credit for withholding tax

shown on form W-2, box #17). RI does not follow the MA “rule.”

Saturday, February 12, 2022

Earned Income Credit for Seniors?

 

William Delaney, EA
Westwood, MA
SENIOR CITIZENS (OVER AGE 64) ARE NOT ELIGIBLE FOR THE EARNED INCOME CREDIT (at least they were not for 2020).  HAS ANYTHING HAPPENED TO CHANGE THAT? 

 

Is my software going crazy---it is allowing an EIC (when the income qualifies) for my 69 year old taxpayer who works part-time at the supermarket, bagging groceries!  This can’t be right—he didn’t get it last year!  So, your Editor looked it up in The Tax Book and, sure enough, there it is on page 11-10:

 

NEW FOR 2021 – Individuals over age 65.  For 2021, this age limit is eliminated.

 

That’s close, but not quite right.  The American Rescue Plan Act of 2021 removed the  age 64 limitation, but only for tax year 2021.  See Subtitle F, Part 3, §9621(a)(n)(2) of the Act.  Don’t look a gift horse in the mouth---go for it!

Friday, February 11, 2022

Backup Withholding Required When No TIN

Mary Mellem, EA

We find two issues in this case:  1) backup withholding, and 2) the statute of limitations.

 

James Quezada works as a stone mason and owns Quezada Masonry.  Mr. Quezada hired subcontractors to perform much of the work, and timely filed his Forms 1099.  For 2005, Mr. Quezada filed 39 Forms 1099, of which 30 lacked Taxpayer Identification Numbers (TINs).  Forms filed for 2006, 2007, and 2008 were similar.

 

BACKUP WITHHOLDING – IRC Section 3405(a) addresses the backup withholding requirements by stating a taxpayer must withhold at the 4th individual tax rate (currently 24%) in any of four events.  The first event listed (Section 3405(a)(1)(A)) is “the payee fails to furnish his TIN to the payer in the manner required.”

 

Most of the Forms 1099 filed with IRS failed to show TINs.  Therefore, Mr. Quezada was required to do backup withholding.  He did not file Form 945 to show the backup withholding, nor did he turn over any monies to IRS.  The Court of Appeals agreed Mr. Quezada was responsible to backup withhold.

 

This should be a warning to taxpayers who do not have the recipient’s TIN at the time payment is to be made, that the taxpayers should backup withhold and subsequently file Form 945 to turn the funds over to IRS.

 

STATUTE OF LIMITATIONS – In 2014 IRS assessed about $1.2 million for amounts Mr. Quezada failed to backup withhold from 2005-2008, plus penalties and interest.  Mr. Quezada argued the statute of limitations had expired on these years, starting when his Form 1040 and Forms 1099 were filed since IRS could determine his liability for backup withholding.  IRS contended the statute had not started yet, since IRS’ regulations prescribe Form 945 as the “return” to be filed to show backup withholding and this form was not filed for any of these years.

 

Court of Appeals, 5th Circuit, sided with the taxpayer.  The net result of these two issues is IRS’ assessment was past the statute of limitations, even though Mr. Quezada was responsible to backup withhold.

 

Also of note – the time frame between the years involved (2005-2008) and the IRS initial assessment in 2014.

 

IRS has stated it will not acquiesce to this position.  In other words, IRS will not follow the 5th Circuit’s position outside of the 5th Circuit.  (The 5th Circuit Court of Appeals includes Texas, Louisiana, and Mississippi.)

 

 

James Quezada & Simona Quezada, CA-5, No 19-51000, December 11, 2020

 

 

This text has been shared courtesy of:  David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065, fax 920-496-9111, ataxprof.com.

Wednesday, February 9, 2022

Last Week's Partnership Question - What is The Answer?

In general, when a partner receives property in a complete liquidation of his partnership interest, it is not a taxable event; his basis in the property is his outside basis (adjusted basis) in the partnership.  However, as has been said so many times and in so many situations, the devil is in the details!

 

In our example from last week, Jeff received $5,000 in cash.  §732(b) provides that any money distributed (i.e. cash) is applied to reduce the partner’s adjusted basis in the property.  So, now we reduce $185,000 (adjusted basis before distributions) to $180,000 (adjusted basis after money distributions). 

 

But, we are asked for Jeff’s basis in the building only, not his adjusted basis in all of the property distributed, so we need to do an allocation and split up the $180,000.  §732(c) to the rescue, but easy it is not…

 

(c)(1)(A)(i)(ii) do not apply so we move on to (c)(1)(B)(i) and assign basis to the building and the land in accordance with inside basis (partnership’s basis).   $100,000 + $50,000 = $150,000, which is short of $180,000 by $30,000.  When we have unallocated basis (i.e. $30,000) we then look to (c)(1)(B)(ii) which tells us to defer to either (c)(2) or (c)(3), “whichever is appropriate.”  To avoid making matters more complicated than needed to throw you all off (including, alas, your Editor), it turns out that (c)(2)(A) applies (since both properties have appreciated in value) and we never get to (c)(2)(B) (thank God for little favors).

 

(c)(2)(A) requires us to allocate the $30,000 proportionate to FMV ($100,000 + $50,000 = $150,000) FMV…

 

Building $100,000/$150,000 x $30,000 = $20,000

Land $50,000/$150,000 x $30,000 = $10,000

 

To the answer:

 

Building - $100,000 + $20,000 = $120,000 (answer 4 to last week’s question)