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A taxpayer was disallowed dependency exemptions for his son, daughter and grandchild in a January 2015 U.S. Tax Court case. The court also denied him head-of-household filing status.
This decision (Gregory McBride v. Commissioner, U.S. Tax Court, T.C. Memo. 2015-6, Jan. 8, 2015) cost the taxpayer $3,540 in additional federal income taxes and penalties of $708.
During 2010, Gregory McBride and his son, daughter and granddaughter all lived together in McBride’s home.
On Feb. 28, 2011, McBride’s son filed his Form 1040 income tax return, claiming himself as a personal exemption. Also on that date, McBride’s daughter filed her Form 1040. She claimed $11,892 in gross income.
McBride’s daughter claimed a personal exemption for herself and a dependency exemption for her daughter. She received a refund of $5,290, due mostly to a refundable credit of $4,450.
McBride had requested a filing extension for his 2010 return. He timely filed his return on May 23, 2011, claiming head-of-household filing status and dependency exemptions for his son, daughter and granddaughter.
A taxpayer can claim a dependency exemption for someone who is a qualifying child or a qualifying relative.
The IRS requires a taxpayer to meet a five-part test to claim an exemption for a qualifying child. The taxpayer must meet the requirements of all five parts to claim this exemption. One of the parts is an age test.
The dependent child must be under the age of 19 or a student and under the age of 24 as of the end of the tax year, which in this case was Dec. 31, 2010. The facts in this case stipulated that both the son and the daughter were over the age of 24, so the age test was not met and McBride would not be able to claim his children as dependents.
There is an exception – which did not apply in this case – for an individual who is permanently and totally disabled.
McBride could claim neither his daughter nor his son as qualifying relatives because he did not present any evidence that he provided more than 50 percent of their support during the year. A taxpayer must meet the support test to claim someone as a dependent relative. In the case of his daughter, McBride did not meet the support test.
McBride could not claim his granddaughter as a dependent because the mother had already claimed her. The Internal Revenue Code has a special “tie-breaker rule” when multiple taxpayers are claiming the same child as a qualifying child. In these cases, the child is treated as the qualifying child of the taxpayer who is the parent – in this case, the mother.
The court denied McBride’s claim for head-of-household status. To claim this status, a taxpayer must be unmarried at the end of the tax year and provide a home for a dependent for at least half of the year.
Because the son, daughter and granddaughter were not considered to be dependents by the court, McBride did not meet the criteria for head-of-household filing status. Therefore, the court disallowed all three dependency exemptions and the head-of-household filing status.
©2015 CPAmericaInternational
The U.S. Tax Court recently determined that a cash method taxpayer is entitled to claim an American Opportunity Credit only in the tax year when the payment was actually made – not for the academic year when the tuition payment was paid.
John and Brenda Ferm paid their daughter’s tuition at the local community college for the 2011 winter semester, which ran January through April 2011. They made the tuition payments in three installments with the majority of the tuition paid on Dec. 28, 2010.
The taxpayers timely filed their 2011 income tax return, but they did not claim the American Opportunity Credit, a tuition credit available to parents of dependent children who are undergraduate students.
On April 1, 2013, the taxpayers filed an amended return. On the amended return, the taxpayers claimed an American Opportunity Credit of $2,107.
On June 13, 2013, the IRS sent the taxpayers a notice of deficiency disallowing the American Opportunity Credit for lack of payment verification.
The taxpayers filed a petition in court contesting the IRS in its disallowance of the credit.The taxpayers provided the court with the appropriate evidence that the tuition had been paid. The court disallowed all but $157 of the credit because $2,151 of the qualified educational expenses was paid in 2010, not in 2011.
The portion of the tuition paid in 2010 cannot be used to claim a credit in 2011. Only $157 of qualified tuition and related expense was actually paid in 2011.
The American Opportunity Credit is allowed only when payment is made in the same year that the academic period begins.
When a taxpayer prepays qualified tuition and related expense during one taxable year for an academic period that begins during the first three months of the following taxable year, the academic period is treated as beginning during the taxable year in which payment was made.
In this case (John Mark Ferm and Brenda Kay Ferm vs. Commissioner, T.C. Summary Opinion 2014-115, Dec. 30, 2014), the academic year and the majority of the tuition payments were considered 2010 transactions, not 2011, explaining the court’s disallowance of most of the credit.
The Tax Court’s opinion in this case may not be used as precedent for any other case.
©2015 CPAmerica International
Certain expiring tax provisions were extended on Dec. 19, 2014, when President Obama signed into law the Tax Increase Prevention Act of 2014.
Some interesting examples of tax law extended on the individual income tax side are:
These provisions of the Internal Revenue Code were set to expire in 2014. With passage of this new law, you are still able to take advantage of these provisions in 2014.
These are just a few examples of the various individual tax law provisions that were extended. A number of business income tax provisions were extended as well.
The law (P.L. 113-295) also included technical corrections to the Internal Revenue Code of 1986.
©2015 CPAmerica International
Joseph Sanchez mailed a petition challenging a deficiency assessed against him by the Internal Revenue Service. Unfortunately for Sanchez, the IRS dismissed his petition because the agency did not receive it in a timely manner.
This situation involved a dispute over Sanchez’s tax year 2010 individual income tax return. The IRS sent Sanchez a notice of deficiency claiming that he owed approximately $13,000 of additional tax, penalties and interest.
The letter from the IRS clearly stated that Sanchez had 90 days from the date of the letter to file a petition with the U.S. Tax Court. The letter even stated the “last date to petition the tax court: March 3, 2014.”
On March 3, 2014, Sanchez had a third party deliver to the U.S. Postal Service a letter containing his petition to the IRS. This petition was Sanchez’s response to the deficiency assessed against him.
The third party even gave a written statement to the court, claiming she had delivered the letter containing the petition documents to the post office on March 3, 2014. She further stated that, instead of waiting in a long line, she had dropped the petition paperwork off at the post office without having a certified mail receipt stamped by a post office employee.
Therefore, the third party had no documentation showing that the post office had received the package on March 3, 2014.
The court actually received the petition documents on March 10, 2014. The envelope containing the petition documents had a U.S. Postal Service postmark date of March 4, 2014.
On the envelope was also a stamp printed on a computer by a third party using software from Stamps.com, as well as a certified mail sticker. The stamp showed the date of March 3, 2014.
The IRS has a section in its regulations that deals with this issue. The regulation section provides that “if the envelope has a postmark made by the U.S. Postal Service in addition to a postmark from another entity, the postmark made by the other entity is disregarded. In determining whether the envelope was mailed in a timely fashion, the date provided by the U.S. Postal Service is the date used.”
In this case, that date was March 4, 2014. For Sanchez to have made a timely response, he would have needed to have his envelope postmarked no later than March 3, 2014.
Therefore, the court had no choice but to dismiss the case on the grounds that the petition was not timely filed. A judgment in the amount of roughly $13,000 was entered on behalf of the IRS (Joseph Sanchez v. Commissioner, U.S. Tax Court, T.C. Memo 2014-223, Oct. 22, 2014).
This situation could have been avoided had the third party delivered the letter to the U.S. Postal Service in time to have it stamped as of March 3, 2014.
In today’s low yield environment, where a five year CD yields 1.5%, publicly traded partnerships (PTPs) have been proliferating. These are companies, usually associated with oil and gas, that are required to distribute their “distributable cash flow” and avoid the double taxation that is inherent to corporations. 
They usually have yields in excess of 5% with the biggest names in the sector such as Kinder Morgan yielding 6.8%, Energy Transfer Partners 6.7%, Linn Energy 9.4%, and Enbridge Energy Partners 6.6%, just to use a few as examples.
So what is the downfall of these high yields? – Cost. Owners of these PTP’s, no matter how small, receive a K1 for their share of the earnings. Having multiple K1s creates an inordinate of time for tax preparation. On these K1s there is usually ordinary income, interest, capital gains and losses, intangible drilling costs, and alternative minimum tax items that CPA’s have to contend with. And these are just some of the pass-through items.
Recently, Kinder Morgan decided to do away with their complex PTP and combine with their general partner to create a regular C Corporation. They did this to make a simpler structure and reduce their borrowing costs. 
This disclosure made their stock go up almost 20% in a day. But wait, there is a caveat. Upon this conversion, all holders of KMP units that are to be converted into this new company will have to pay capital gains taxes. This can be a complicated calculation with the distributions received over many years that weren’t taxable combined with income or losses that have accrued that may or may not have been deductible.
For PTPs, as with any investment decision, it is important to weigh the tax consequences and costs. 
This is an area where CPAs can come in handy; we aren’t here just for April 15!
If you participate in wagering, or gambling, your taxable gains from those transactions can be reduced by your wagering losses – even if the underlying dealings are illegal.
However, wagering loss deductions are subject to a number of limitations:
➜ These losses can be used to offset winnings only during the same year, and not to offset any other types of income for that year. You may not use losses as a carryback or carryforward to reduce gambling income in earlier or later years.
➜ The losses can be claimed only as itemized deductions unless you are in the trade or business of gambling.
➜ The losses must be verified with adequate documentary evidence or other evidence, other than your personal assertion. The courts have been consistent in the past in ruling against taxpayers who have not kept detailed documentation regarding gambling losses.
If you are gambling at a casino, a good tip to follow is to use a player’s card that casinos hand out to their patrons. This card helps to keep detailed track of your activity on a daily basis. It helps track both your wins and losses.
You can use the card to print out an activity summary. The summary shows both your wins and losses on a daily basis. This is the type of independent third-party documentation that the IRS wants to see.
Losing lottery tickets would be another example of the type of documentation needed to support that gambling loss deduction.
Remember that gambling losses can be used only to offset gambling winnings. But to make sure you receive the gambling loss to which you are entitled, make sure you have adequate documentation.
A stiff prison sentence imposed by a district court on an individual convicted of filing a false refund claim and interfering with the administration of internal revenue laws has been upheld by the U.S. Court of Appeals for the Eleventh Circuit.
Taxpayer Donus R. Sroufe had submitted an unsigned Form 1040 return to the Internal Revenue Service for tax year 2008. The return contained fictitious revenue items from various sources, including the United States Department of Treasury. The total amount of income reported was $2.5 million.
Sroufe also listed a number of companies that supposedly had made estimated income tax payments to the IRS on his behalf. Sroufe claimed that such payments totaled more than $2.6 million. The tax return stated that a refund was due in the amount of nearly $1.76 million.
In addition to the tax return, Sroufe submitted a Form 56, Notice Concerning Fiduciary Relationship, listing the Secretary of the Treasury Department as his fiduciary. He also submitted a letter making an odd request of the Commissioner of the IRS to “file the enclosed 2008 Federal Tax Form 1040 along with any forms and/or returns that may be due, including those that may be required for tax years 2006 and 2007.”
The IRS deemed the submission a frivolous tax return and sent it to the Frivolous Return Program (FRP).
A letter from the FRP informed Sroufe that he had taken a frivolous position and had 30 days to file a correct return to avoid a monetary penalty. The FRP viewed Sroufe’s submissions as an attempt to “delay or impede the administration of Federal tax laws.”
In a reply letter to the FRP, Sroufe stated that he had reviewed his 2008 submissions, which he considered proper and correct.
Sroufe later sent another letter to the FRP stating that the original Form 1040 was incorrect and he was in the process of correcting it. He also said that he intended to complete and file his tax returns for 2006, 2007 and 2008. But he never filed returns for 2006 and 2007 – and never amended or corrected his 2008 return.
The result was that Sroufe was indicted by a federal grand jury for interference with administration of internal revenue laws and filing a false claim against the United States for a tax refund. Sroufe pleaded not guilty, and the case proceeded to trial where he was convicted on both counts.
The judge stated that Sroufe had intended to defraud the IRS and had attempted to obtain a $1.7 million tax refund to which he was not entitled. He was sentenced to 51 months in prison on this charge.
In addition, the judge found Sroufe guilty of interference with administration of internal revenue laws because he had submitted fictitious documentation to the IRS in response to various inquiries from the agency. The taxpayer was sentenced to 36 months in prison on this charge (United States of America v. Donus R. Sroufe. U.S. Court of Appeals, Eleventh Circuit, 2014-2 U.S.T.C.).
Both sentences were at the high end of the sentencing guidelines due to the taxpayer’s prior issues with the IRS. The sentences are to run concurrently.
©2014 CPAmerica International
File your tax returns in a timely manner, or your filing status may be determined for you – by the IRS.
That’s the lesson Donald Thomas Salzer and his wife learned the hard way. They failed to file income tax returns for 2008 and 2009. Mrs. Salzer had refused to sign the 2008 and 2009 tax returns for political reasons.
Salzer and his wife had filed under the married filing jointly status from 1985 through 2007. However, when the IRS prepared returns for Salzer and his wife for 2008 and 2009, it selected the filing status of married filing separately for the taxpayers.
The difference in tax rates between the two filing statuses caused the taxpayers to have a deficiency on the returns for both years in question. Under normal circumstances, with the taxpayers filing jointly, they would have received a refund as they did in 2007. The amount of the 2007 refund was $1,375.
The taxpayers’ situation in 2008 and 2009 was almost identical to that of 2007. Salzer was still married, still had two dependents, had the same job, and was withholding in a similar manner. The taxpayers would have received a refund for 2008 and 2009 had the returns been prepared with the filing status of married filing jointly.
The Tax Court ruled recently that an individual was not entitled to claim joint filing status for a return prepared by the IRS after the individual and his wife failed to file a return for two years. The court further stated that joint return rates apply only if a married individual files a return jointly with his or her spouse. Joint filing status cannot be imputed. (Donald Thomas Salzer v. Commissioner, T.C. Summary Opinion 2014-59, June 24, 2014)
The court imposed penalties for failure to timely file and pay tax since the husband failed to address the penalties at trial. The amounts of the penalties are still in dispute and will be settled by the U.S. Tax Court Rules of Practice and Procedure.
Take seriously your responsibility to file your tax returns in a timely manner. If the IRS has to prepare your returns for you, under certain circumstances, they can change your filing status.
This case was tried in the U.S. Tax Court Small Case Division. The decisions do not serve as precedent for other taxpayers but are indicative of how the Tax Court may rule in a similar situation.
©2014 CPAmerica International
Can you imagine waiting for your tax refund – and it never arrives?
Not because you don’t deserve it or the IRS didn’t send it, but because your tax preparer substituted his bank routing number for yours after you signed the form.
And then, worse news, the IRS doesn’t reimburse you for your loss.
That scenario has happened to hundreds of taxpayers who made the mistake of trusting unscrupulous, uncredentialed preparers.
But preparer fraud victims are at the back of the line when it comes to getting a refund from an IRS barraged with hundreds of thousands of identity theft cases it is processing.
In fact, the IRS has generally declined to issue refunds to victims of preparer fraud at all, according to National Taxpayer Advocate Nina Olson.
“The IRS has consistently dragged its heels, making one excuse after another, because providing relief to these victims just is not a high enough priority, or more disturbingly, because the IRS simply does not want to provide relief,” says Olson in the report she submitted to Congress and the IRS entitled “Areas of Focus, Return Preparer Fraud: A Sad Story.”
Between 2000 and 2011, the IRS Office of Chief Counsel issued four opinions and other guidance authorizing the IRS to issue replacement refunds to the victims of tax preparer fraud.
But no refunds have been issued by the IRS, Olson said.
Some victims have been waiting since 2008 to be reimbursed, the advocate’s office reports.
One section of the new Taxpayer Bill of Rights adopted recently by the IRS states, “Taxpayers have the right to expect appropriate action will be taken against employees, return preparers and others who wrongfully use or disclose taxpayer return information.
“Nowhere has the IRS failed to abide by the Taxpayer Bill of Rights more than with respect to the issue of return preparer refund fraud,” Olson said.
Olson’s report said IRS Commissioner John A. Koskinen decided in March that the IRS would issue refunds to victims who have filed police reports and met certain other substantiation requirements. To date, the IRS hasn’t implemented that decision or given a date for victims to expect refunds, Olson said.
To help prevent future fraud, Olson reiterated her longstanding recommendation that a meaningful preparer standards program must contain four components:
A Pennsylvania professor was fined $10,000 by the Tax Court on July 31 for repeated frivolous arguments about deductions on his tax returns.
Alvin Kanofsky, a physics professor at Lehigh University since 1967, was continuing to protest a federal tax lien for unpaid taxes for 1996, 1997, 1998 and 2000.
Kanofsky was ordered to pay the taxes in a 2006 Tax Court Memorandum decision, which was reaffirmed on appeal in 2008. He reappeared again before the court in the subsequent levy case in 2010. Three attempts by Kanofsky to have the case heard by the Supreme Court were denied. In February of this year, the IRS requested a summary judgment because payment hadn’t been received and asked for a penalty to be imposed.
The unpaid taxes concerned Schedule C deductions that Kanofsky claimed had offset any tax liability for the years in question. The tax deficiency in this case totaled over $41,000, not including penalties.
At issue was a building he owned near Lehigh University, which he said he used for business purposes. Expenses he claimed included building repairs, mortgages and interest. He said all of his materials in the building had to be cleared out because he “ran into a worldwide scam.”
Many of the documents Kanofsky tried to show the court to support his claim were not admitted because of IRS objections. His appeals were based on what he called the Tax Court and IRS unfairly “suppressing” important information in the case. Kanofsky said that he and his late brother were whistleblowers in a number of instances of fraud and that he has been subjected to retaliation because of the whistleblowing.
Earlier Kanofsky had filed suit related to taxes due for 2006 and 2007, of $26,033 and $45,433 respectively, which the U.S. Court of Appeals for the Third Circuit in 2013 agreed were owed to the IRS. The court held that “neither the Tax Court nor the IRS improperly obstructed petitioner’s presentation of evidence” and “allegations of fraud and corruption and his assertion of ‘whistleblower’ status were irrelevant to the merits of his case.”
“He did not explain to the Tax Court, and does not explain now, how events as disparate as the Sandusky prosecution or alleged corruption related to the Barnes Foundation have any bearing on his tax liability,” the Court of Appeals further stated.
In its summary decision on July 31, 2014, the Tax Court said, “Petitioner is no stranger to this court. He was warned in prior proceedings that his conduct could subject him to a penalty if he continued to repeat arguments he made in earlier cases.
“He has returned for a fourth time to this court, once again raising his arguments about fraud, corruption and whistleblowing activities. … He has repeatedly asserted irrelevant and meritless arguments. He designed his petition to delay the collection of the income taxes he owes.”In rendering its decision, the Tax Court said it has unequivocally warned taxpayers about abusing procedural protections by pursuing frivolous actions for the purpose of delaying payment.
“Petitioner is a well-educated individual who admits that he understood cautions and warnings given by the court, yet he continues to reiterate the same irrelevant and groundless arguments. He has wasted the time and resources of both the [IRS] and the court.”
The court warned Kanofsky that additional penalties would be applied if he continued to raise “irrelevant, frivolous and groundless arguments or institutes or maintains further proceedings in this court to delay the payment of federal income tax lawfully assessed against him” (Alvin Sheldon Kanofsky v. Commissioner, T.C. Memo 2014-153, July 31, 2014).
©2014 CPAmericaInternational
