On May 11, 2017, the Tax Court issued a Memorandum Decision (TC Memo 2017-79) that addressed, among other things, the Taxpayer arguing that the software “lured” him into claiming too many deductions on his tax return.
There were a number of issues on this return that caught the eye of the IRS: alimony paid deduction, interest deduction, and deduction for other expenses. When examined by the IRS, the Taxpayer did not have much in the way of paperwork to support his positon for the deductions reported.
In addition to disallowing the majority of the deductions taken, the Taxpayer was assessed an accuracy related penalty for substantial understatement of income tax. For this penalty, the burden shifts to the Taxpayer to show that his mistakes were reasonable and in good faith. “He admitted during trial that he deducted items he shouldn’t have, and that he overstated certain losses. He tried to blame TurboTax for his mistakes, but tax preparation software is only as good as the information one inputs into it,” the Court concluded.
Tax preparation software must be used correctly to be useful for purposes of showing reasonable cause and good faith as a defense to accuracy related penalties. The majority of court cases have rejected this defense.
When preparing your return, ensure you are reviewing the return before filing it. I just received a phone call this week from someone that was asking if his tax software was properly calculating the tax on rental property he had sold. A first for him. I commend him for wanting to understand what he was filing.
Remember: You can’t blame the software!
National Taxpayer Advocate Nina E. Olson released her 2015 annual report to the Congress on January 6, 2016. Olson expressed her concerns that the IRS is scaling back telephone and face-to-face services to assist the nation’s individual taxpayers and business entities in complying with their tax obligations.
In addition, other key issues were addressed in the report. Of particular interest is the growing rate of false positives in a key tax fraud filter used by the IRS in processing returns. The rate of false positive in 2015 was about 36 percent, affecting nearly 180,000 taxpayers. The “Anti-Fraud Filters” are used to filter out improper refund claims.
Olson’s report states that The Pre-Refund Wage Verification Program, “income wage verification,” allows the IRS to temporarily freeze a taxpayer’s refund when possible false wages and withholding are detected. The IRS sends out notices to taxpayers whose returns were flagged by the filters and instructs them to authenticate their identities online, by phone or by mail.
Following is an actual case of a legitimate refund that is still being withheld by the IRS. The 2014 tax return of the taxpayer was electronically filed and accepted by the IRS on October 11, 2015. A notice to verify the income and withholding was received on November 1, 2015. A copy of the taxpayer’s form W-2 was sent to the IRS on November 2, 2015. By January 7, 2016, the refund still had not been received. A telephone call was placed to the IRS and found out they still had not processed the return (the taxpayer was lucky to have gotten through without being hung up on). It’s been 16 weeks since the return was accepted, still no refund. Time to call the Taxpayer Advocate.
The intention of the Anti-Fraud Filters is to protect the taxpayers. However, it is very frustrating when legitimate refunds are delayed for excess amounts of time and contacting the IRS is nearly impossible.
Identity theft can be a devastating experience that can turn a person’s life upside down. In an effort to combat identity theft and financial crimes in general, the IRS Criminal Investigation examines possible criminal violations of the Internal Revenue Code and related financial crimes, including fraud related to identity theft. Each year, the Criminal Investigation gathers and releases statistics on the number of investigations initiated, prosecution recommendations, indictments or informations, and convictions as well as the incarceration rate and average number of months sentenced to serve. For the fiscal year ending September 2015, there were 3,853 investigations initiated, 3,289 prosecution recommendations, 3,208 indictments or informations, and 2,879 convictions. For identity theft investigations in particular, the statistics were as follows: 776 investigations initiated, 774 prosecution recommendations, 732 indictments or informations, and 790 sentencings. The incarceration rate for identity theft related crimes was 84.6% and the average number of months sentenced to serve was 38.
To help victims of identity theft resolve their cases, the IRS recently changed its former policy of refusing to provide copies of fraudulently filed tax returns. Recognizing a victim’s need to figure out just what personal financial information was stolen and how it was used, the IRS now allows taxpayers to acquire copies of tax returns filed fraudulently under their social security numbers. In order to request a copy of a fraudulent return, however, there are strict requirements that need to be met. One of the requirements is that the victim’s name and social security number must be listed as the primary or secondary taxpayer on the return; dependents cannot make requests. In addition, the underlying fraud case must have been settled by the IRS at the time of request. Finally, the copy of the fraudulent return will be redacted to conceal any information that might be related to additional possible victims. For more information on requesting copies of fraudulent returns, go to the IRS website.
There are many things you can do to protect yourself against identity theft. Here are some helpful tips that are listed on the IRS website:
For many years now, the IRS has been continually warning the public about the ever-changing tax scams used by individuals to take advantage of unsuspecting taxpayers. These schemes can take place by mail, email, or over the phone and most often involve tricking the taxpayer into giving up personal financial information or intimidating the taxpayer into making fake tax payments directly to the scammer. On August 6, 2015, the IRS released yet another warning to taxpayers alerting them to new variations of these scams.
One of the most common schemes is deception over the phone by impersonating an agent of the IRS or another governmental agency. The new variation of this scheme involves the use of technology. Nowadays, scammers have the ability to change what shows up on a taxpayer’s caller ID to make it appear as if it is a legitimate call from the IRS or another agency, such as the DMV. In addition, to make the call seem genuine, they will gather as much of the taxpayer’s online personal information as possible. Finally, they will use false names, titles, and badge numbers to try to establish their fraudulent identities.
Another way to deceive taxpayers is by mail. In some circumstances, scammers will duplicate official IRS letterhead and direct taxpayers to the nearest bank or business at which they can make payments. Some fraudsters will even provide an actual IRS address to which the victim can send his or her proof of payment.
The IRS stresses that the underlying factor of these scams is fear. Scammers will often use threats of arrest, deportation, or license revocation. In addition, they will emphasize that the matter is urgent and requires immediate attention. The IRS also highlights that while scammers used to only target vulnerable individuals, such as elderly taxpayers or taxpayers whose first language is not English, this is no longer the case. Today, any taxpayer is at risk. In fact, according to the IRS, the Treasury Inspector General for Tax Administration has received approximately 600,000 complaints since October 2013. In addition, there have been over 4,000 victims with a combined total of $20 million in financial losses due to these scams.
In order to protect yourself, here are a few of the tips that the IRS has listed on its website. The IRS will never:
For more information on how to protect yourself or what to do if you find yourself a target, go to the IRS website.
In a recent case, an appeals court upheld the Tax Court’s decision that a bookie’s plea agreement on criminal charges does not bar a civil action for unpaid taxes.
Gary Kaplan operated an illegal sports booking business called BetOnSports. The majority of Kaplan’s booking business was located in the Caribbean islands and Costa Rica for most of the 1990s.
Right before the company went public in July 2004, Kaplan engaged in several transactions and stock transfers that allowed him to set up two trust funds worth $98 million dollars. These trusts were referred to as the “Bird Trusts,” and the money was located somewhere off the coast of France.
Kaplan was the sole grantor of the Bird Trusts. As the grantor of the trusts, Kaplan was responsible for paying income taxes on the earnings of the trusts. Kaplan neglected to pay federal income tax or capital gains tax for the trusts for either 2004 or 2005.
In 2006, Kaplan was indicted by a federal grand jury for operating an illegal bookmaking operation within the United States. Kaplan ended up making a plea deal with the government. In exchange for accepting reduced charges, Kaplan agreed to allow the federal government to take civil action against him regarding the two years at issue.
During a change-of-plea hearing in 2009, Kaplan was questioned about the provision in his original plea agreement that dealt with the right of the government to pursue a civil tax matter against him for the 2004 and 2005 tax years. Kaplan assured the judge that he understood the difference between a civil court matter and a criminal court matter. He insisted that he was aware of the ramifications of the plea deal.
After the change of plea hearing, the court accepted the plea offer and sentenced him to 51 months in jail and ordered him to forfeit $43.65 million to the United States.
Sometime in 2012, the IRS commissioner issued a notice of deficiency for failure to file and pay taxes for 2004 and 2005. Kaplan was also liable for interest and various penalties. The taxes, penalties and interest totaled almost $25.5 million for 2004 and a little over $11 million for 2005.
Kaplan challenged the IRS at the district court level and lost. He brought his appeal to the U.S. Court of Appeals for the 8th Circuit.
Kaplan raised three issues in his appeal:
1. The statute of limitations had run on the commissioner’s ability to assess the unpaid taxes.
2. His 2009 plea agreement barred the claim.
3. Judicial estoppel barred the commissioner’s determination.
The appeals court rejected all three of these issues.
The statute of limitations does not start to run until an income tax return is actually filed by the taxpayer. Because the taxpayer did not file a tax return for 2004 and 2005, the statute of limitations has not run on those tax years. So Gary Kaplan lost on this issue.
The 2009 plea agreement was unambiguous as to the government’s ability to bring a civil action against Gary Kaplan. In addition, during the 2009 change-of-plea hearing, the court referenced answers given by Gary Kaplan that clearly demonstrated that he understood the government had the ability to bring a civil tax proceeding against him.
On the issue of judicial estoppel, Kaplan felt that, because the government did not object to his Presentence Report, it was prevented from bringing a civil tax proceeding against him. In his report, Gary Kaplan did not list any tax liabilities for 2004 and 2005. There were a number of reasons that Kaplan lost this issue, including that the numbers contained in the report were compiled and put together by Kaplan himself, not the IRS. (Gary Kaplan v. Commissioner, U.S. Court of Appeals, Eighth Circuit, 14-2342, July 29, 2015) ■
©2015 CPAmerica International
The U.S. Tax Court recently upheld the IRS’s frivolous return position, costing a taxpayer $10,000 in fines.
Mark A. Lovely failed to file tax returns for 2005, even though he admitted that he had received compensation from Tradewinds Airline, Inc., and Triad International Maintenance Corp. He claimed the compensation did not constitute “wages” and therefore it was not taxable income.
Each of Lovely’s employers issued to him a Form W-2 Wage and Tax Statement. Because the IRS receives a copy of every W-2, the agency knew that Lovely had earned income and a requirement to file a tax return.
Using this information, the IRS prepared a substitute return for Lovely and assessed income tax, penalties and additions to tax.
In July 2009, Lovely prepared a Form 1040X, Amended U.S. Individual Income Tax Return. He claimed that he had no income for the tax year at issue, which was 2005. He in fact had $29,500 worth of taxable compensation for that year. He requested that the federal income tax amount of $1,475.37, which had been withheld from his wages, be refunded to him.
In September 2012, Lovely followed a similar procedure. This time he filed a 1040X requesting a refund of $781.51.
The IRS determined that both Forms 1040X submitted by Lovely had constituted frivolous returns and assessed a $5,000 fine for each one submitted.
In a collection due process hearing with the IRS, Lovely contested the $10,000 in fines assessed by the IRS for his having submitted frivolous returns. He claimed he did not receive a statutory notice of deficiency and did not have a proper opportunity to dispute the fines.
Both of the issues raised by Lovely are defenses to the existence of the amount of the tax liability according to the Internal Revenue Code. The tax liability in this case was the $10,000 in fines.
The IRS brought up some prior court cases that supported the position that issuing a statutory notice of deficiency and allowing the taxpayer an opportunity to dispute the tax are not required when the taxpayer’s original position on the 1040X is frivolous.
Lovely agreed that he had received compensation for his services but contended that it was not taxable income because he didn’t work for the federal government. The court ruled that his tax-protestor-type arguments in support of his position were frivolous.
Taking all of the facts and circumstances of the case into account, the Tax Court ruled in favor of the IRS and upheld the $10,000 in fines (Mark A. Lovely v. Commissioner, T.C. Memo 2015-135, July 27, 2015). ■
©2015 CPAmerica International
Nonemployee compensation received in exchange for services rendered is taxable income, despite tax protester arguments to the contrary.
Stephan Foryan, a resident of the state of Washington and an apparent tax protester, did not file a tax return for 2009. He also did not make any estimated tax payments for the 2009 tax year.
Foryan admits to having received nonemployee compensation for services rendered, but he told the U.S. Tax Court that the compensation was not taxable. He mistakenly relied on a court case from 1920 to support this argument. Unfortunately for him, a 1955 Supreme Court case superseded the 1920 case, making it not applicable to the present matter.
Internal Revenue Code Section 61(a) provides that “gross income means all income from whatever source derived,” including compensation for services.
Using information obtained from third parties, the IRS had calculated Foryan’s income for 2009 to be $137,282. Against this income, Foryan was allowed a self-employment income tax deduction of $8,460, a standard deduction of $5,700 and a personal exemption of $3,650.
Foryan had been involved in a prior court case a few years earlier regarding a tax matter. He lost that case, and the court put him on notice regarding raising tax protester arguments.
The same situation arose in this case. The court rejected Foryan’s arguments as frivolous tax protester arguments. In addition, the court fined him $1,000 because it felt that his position in this case was frivolous or groundless.
Therefore, the court agreed with the IRS in this case, finding that Foryan had received $137,282 in compensation for services performed at various farms during the year and including that amount in his gross income for 2009. He was allowed the deductions calculated by the IRS (Stephan Foryan v. Commissioner, U.S. Tax Court, T.C. Memo 2015-114, June 22, 2015). ■
©2015 CPAmerica International
On May 26th the Internal Revenue Service announced that more than 100,000 accounts from the “Get Transcript” application had been accessed by unauthorized individuals (i.e. criminals). The data stolen consisted of Social Security information, dates of birth and street addresses along with prior year tax transcripts. Access to the Get Transcript application has been disabled, but the damage has been done for the more than 100,000 taxpayers that had information stolen.
The IRS has said their systems were not actually hacked, but rather the criminals gained access to individuals’ tax data through personal information already in their possession. One of the many previous breaches of our personal data has left plenty of information in the hands of these less than savory characters. Even though the Get Transcript application requires users to answer several personal questions, the information already floating around out there in the dark corners of the internet allowed these criminals to successfully answer the “challenge” questions that allow people to access prior year tax transcripts.
The bummer about all of this is the inconvenience and headache this will cause those taxpayers who are affected. Additionally, the head of the IRS, John Koskinen, told Congress that up to $39 million has been stolen due to the criminals filing fraudulent tax returns with information obtained from the data breach. The Commissioner also went on to say that these cyber-criminals made about 200,000 attempts to get taxpayer data, so this wasn’t a one time smash and grab attack. To add insult to injury, the Treasury Inspector General J. Russell George told Congress that the IRS had not acted on recommended security improvements that would have made the cyber-criminals attempts more difficult. And oh yeah – the IRS is also running 19-year old security software and still runs Windows XP. Microsoft stopped supporting Windows XP a year ago and it has been wide open to hacking attacks ever since.
The IRS will be sending letters to the approximately 200,000 taxpayers whose accounts had attempted unauthorized accesses. For the more than 100,000 taxpayers whose accounts were accessed, the IRS will be offering free credit monitoring. Affected taxpayers will also have will have additional flags on their IRS accounts to hopefully detect any potential fraud.
James A. Ericson really missed the mark as a federal income tax preparer.
In February 2015, the U.S. District Court for the District of Hawaii permanently barred Ericson from preparing federal income tax returns.
Ericson had prepared a large number of income tax returns in which he took unrealistic and unsustainable positions on clients’ tax returns. He willfully understated taxes due and had a reckless and intentional disregard for tax rules and regulations.
The 9th U.S. Circuit Court of Appeals does not have a clear standard or test for the district court to apply in determining whether a lifetime or permanent ban against all tax return preparation is proper. However, the courts have considered a variety of factors in analyzing this issue.
The following are some of the factors considered by the courts through the years in determining whether a lifetime ban is appropriate:
1. A defendant’s willingness or refusal to acknowledge wrongdoing
2. Compliance with the law following a warning or notification by the IRS that the conduct is unlawful
3. Percentage of tax returns filed that are fraudulent
4. Severity of the harm, i.e., the amount of money fraudulently requested and the amount actually and erroneously released
5. Number of discrete fraudulent practices
6. Longevity of the fraudulent scheme
7. Defendant’s degree of “scienter,” or knowledge
The facts and circumstances of the case indicate that Ericson performed negatively under all seven factors.
Regarding the first factor, Ericson has always maintained his innocence under cross-examination. He was warned by the IRS back in 2009 that his practices were improper, and he was fined.
Ericson continued preparing improper returns for the next three years, violating the second factor.
Ericson severely violated the third through fifth factors. The IRS examined 611 federal income tax returns of his clients from 2007 through 2012 and found a total tax shortfall of more than $2.4 million. This amounts to an average of almost $4,000 per return, and when projected over all of the returns that Ericson prepared, a loss to the U.S. Treasury of over $30 million in revenue. Between 86 and 92 percent of Ericson’s clients received a refund.
The sixth factor was violated because this fraudulent activity had been carried out for over five years. The court also found Ericson guilty of the seventh factor because it felt that he knowingly and repeatedly violated the U.S. Tax Code.
Because the court found all of the seven factors against Ericson, it felt it was appropriate to impose a lifetime ban on his ability to prepare individual income tax returns (United States of America v. James A. Ericson, U.S. District Court, District of Hawaii, 2015-1 U.S.T.C. Paragraph 50,222, Feb. 20, 2014).
©2015 CPAmerica International
Tax season is quickly approaching. According to its website, the IRS received 149,684,000 individual income tax returns in 2014 as of December 26, 2014 (2014 Filing Season Statistics). Of these returns, the IRS states that more than half were prepared by hired tax professionals. If you decide to hire a tax professional to prepare your tax return this year, it is essential to choose them carefully to avoid hiring an abusive return preparer.
What is an abusive return preparer?
The IRS defines a return preparer as “any person (including a partnership or corporation) who prepares, for compensation, all or a substantial portion of a tax return or claim for refund under the income tax provisions of the Internal Revenue Code.” An abusive return preparer is a return preparer who engages in return preparer fraud, which involves preparing and filing false income tax returns.
An abusive tax return preparer may use different methods to commit this type of fraud. For instance, he or she may prepare a false Schedule C, Profit or Loss from Business, to claim deductions for fake expenses to counterbalance income derived from outside employment. Another method is to take false and overstated deductions on Schedule A, Itemized Deductions, for charitable contributions and medical expenses. An abusive return preparer may also claim fake Schedule E, Supplemental Income and Loss, losses. Finally, he or she may include impermissible credits or excessive exemptions to lower taxable income or taxes owed.
How do you avoid an abusive return preparer?
To avoid an abusive return preparer, the IRS lists several helpful tips on its website:
Regardless of whether or not you hire a return preparer, remember that you are responsible for the information on your tax return, including all related schedules, forms, and supporting documentation. If there is something on your return that does not make sense or that you do not understand, always ask your return preparer to explain it and correct it, if necessary. You do not want to be liable for additional taxes, interest, and possible penalties when the IRS discovers your false return.