Posted on 01/20/2010
“To every thing there is a season, and a time to every purpose under the heaven” (King James Version).
These oft spoken words were made into a hit popular song by The Byrds, “Turn! Turn! Turn!” The words are prophetic at this time of year. It is once again tax filing season, “a time to get and a time to lose.” A time to get your tax papers together; and, a time to lose sleep over worrying about owing additional tax or suffering a tax audit.
For tax advisors, it is also a time when tax questions from clients proliferate. What else can I deduct is a common inquiry. Some questions are simple and some require a re-reading of portions of the tax law. I never rely on summaries of tax law prepared by others and always go to the source of pain itself – The Internal Revenue Code (Code).
Every time I delve into the Code I am reminded of Joseph Conrad’s most famous novella “Heart of Darkness.” Marlow travels on a boat up the
Like a jungle the Code is a shadowy place where sunlight may seem to penetrate only to be absorbed by dimming shades of evanescing clarity. Sections of the Code are pages long and often define terms by referring to other sections and sub-sections which in turn define other terms by referring to yet other sections and/ or sub-sections. For those taxpayers inclined to try a hand at preparing their own return, I offer Captain Willard’s cautionary words following his frightening encounter with a tiger on a jaunt off the boat, “Never get out of the boat. Absolutely goddamn right! Unless you were goin’ all the way.”
For many, the acronym IRS stands for “I’m Really Scared.” One client told me, “When I receive an envelope from them, I am terrified; I leave it unopened on the kitchen counter for days.”
TAX DISPUTE FORUMS
All this ambiguity in the tax law naturally creates disputes some of which end up in court. There are several courts in which to contest an IRS civil action. There are numerous factors considered by counsel in deciding which court one might want to decide a case, all else being equal. But, frequently taxpayers will end up in the U.S. Tax Court because one can fight about a tax issue there without having to first pay the tax. The Court of Claims and U.S. District Court also hear tax cases but only after one has paid all or part of the tax deficiency and had a refund claim denied.
Nina Olsen, National Taxpayer Advocate, in her most recent address to Congress cites as the number one problem for taxpayers, the complexity of the Code with figuring out how to report foreclosures, short sales and debt cancelation income among the most vexatious of troublesome issues. She finds fault with the IRS Correspondence Examination Program. Well, anyone who has ever received and responded to one of these notices knows that the system is seriously flawed. Often, it seems like your letter has disappeared into a Black Hole that cannot be located even with the Hubbell telescope. IRS Commissioner Douglas Shulman recently admitted using a paid preparer to file his own income tax return because he believes the tax code is too complex.
Even more than the usual confusion reigns during this tax filing season from the many tax changes, extension of benefits like the “first time” and “long term” homeowner credits and uncertainty about near and long term changes in our tax rates and tax structure. We are rafting in rapids on an unchartered river. Doubtless, unforeseen bends and treacherous falls stand ahead.
MOST LITIGATED TAX ISSUES
Ms. Olsen in her report also lists the most litigated issues, namely:
1. Defining gross income. You’d think this issue would be simple but apparently not.
2. Appeals from Collection Due Process Hearing. Taxpayers can request a CDP hearing with an IRS Appeals Officer to contest the reasonableness of IRS collection action (wanting to seize your assets or record a tax lien). You can appeal the appeal result to the Tax Court.
3. Summons Enforcement actions. The IRS can order you or a third party to produce documents. Taxpayers will sometime assert a privilege or other defense against the summons.
4. Disallowance of ordinary and necessary business expenses based on legal grounds or due to lack of supporting documentation (e.g., travel and entertainment).
5. Negligence penalty for positions taken in a return not supported by reasonable authority in the tax law.
6. Suits against IRS for civil damages from unauthorized collection actions of its agents.
7. Contesting the failure to file and estimated tax penalties.
8. Innocent spouse claims
9. Imposition of penalties for asserting frivolous issues in litigation.
10. Issues involving claiming child related tax benefits.
In sum total, the taxpayer prevailed in only 12% of these cases.
WHAT IS THE LESSON?
If you are casting away stones, make sure they are not tied to a noose around your neck. And if you are gathering stones be sure they are not merely a heavy load. You don’t want to end up in court fighting with IRS. It is expensive and most of the time the taxpayer loses. Why? Because, in most instances, the taxpayer must prove that IRS is wrong. In civil tax cases, you are not innocent until proven guilty you are guilty unless proven innocent. Thus, most Tax Court cases favor the IRS holding, “The taxpayer failed to carry the burden of proof.” In other words, the court does not find that IRS is correct, merely that the taxpayer cannot prove IRS is incorrect.
SOLUTION: CAREFUL FILING
Sometimes tax disputes are inevitable. For example, where there is a big dollar questionable deduction or large dollar settlement that may or may not constitute taxable income and about which the courts have not finally decided. In such cases, protective claims for refund can be employed to forestall litigation until the latest possible time in the hope that other litigants will resolve the issue. In most cases, thoughtful tax return preparation can avoid controversy with IRS. A preparer who takes the time to think about the content of your return, employs judgment, discretion, and the most appropriate language in describing items in the return can often avert a needless audit.
WHO’S ON FIRST?
Abbott and Costello confused baseball fans about the players in the field and on base in their classic, hilarious comic routine, “Who’s On First?” But, don’t you be confused about the proper lineup for your team in various tax situations. Some situations are safely in the realm of the CPA tax preparer and some are exclusive to the domain of the tax lawyer.
Your tax preparer may or may not be a lawyer. Even so, tax return preparation is not considered legal representation. There is in fact an invisible line at which point tax accounting ends and tax law begins. Your preparer may or may not know where that line is drawn. Some cautionary situations, however, are:
1. When you want to preserve a privilege. You don’t want to discuss certain matters with a non-lawyer thereby making that person a potential witness (Delinquent returns, amended returns, delinquent Foreign Bank Account Reports, etc.) CPAs have a very limited privilege that goes away if a case becomes criminal.
2. When your tax decisions can limit the court you can later seek redress from such as when you receive a notice of proposed audit changes or a statutory notice of deficiency
3. When you could be waiving due process rights in collection proceedings. . Tax forms for claiming Innocent Spouse status or requesting a Collection Due Process Hearing are deceptively simple but can carry collateral legal consequences.
4. When your action will toll the running of the statute of limitation on assessment, collection or the waiting period for being able to discharge taxes in bankruptcy (Offers in Compromise or CDP Hearing requests).
5. When you receive a notice of filing of the federal tax lien, especially in a divorce context or where bankruptcy is contemplated.
6. When you are contacted personally by more than one IRS agent unannounced. Such contact is almost certainly a criminal matter.
7. When you are served with an IRS summons or Grand Jury Subpoena.
8. When filed tax returns have reported less than all of your income and you must file a Financial Affidavit in a divorce case.
Steinberg Talks Tax (TM), Volume 4, No. 1, January 20, 2010. Copyright 2010 by Robert S. Steinberg, All rights reserved.