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!