Many IRS Audits Are All About What is Not Brought Up
I have been running into more and more taxpayers who inadvertently underreport the amount of income they earn in a particular year due to an employer or brokerage company not sending the taxpayer a timely Form 1099. That is why I am always interested in reading cases where taxpayers are able to successfully avoid the imposition of penalties and interest in these types of situations.
The general rule is that failure to receive a Form 1099 is not necessarily "reasonable cause" for failure to report income. As a result, taxpayers who do not receive Form 1099's are generally are liable for penalties and interest on the unreported 1099 income. Regrettably, there are a number of court cases that support this conclusion. There are also a few court cases where the court found that the taxpayer was not liable penalties and interest that resulted from unreported 1099 income.
Mabinuori v. Commissioner is one such case. In that case the taxpayer employed by MetLife. He was first hired by MetLife as an independent contractor and subsequently hired as an employee. As such, MetLife had issued the taxpayer a Form W2 for his wages as an employee and a Form 1099-Misc for his non-employee earnings.
The court found the fact that MetLife had mailed the 1099 to the taxpayer's prior address and the W2 to the taxpayer's current address significant. Also, the court found that the taxpayer may have reasonably believed that part of his MetLife income was reimbursement for costs of setting up an office.
The court sides with the taxpayer on this issue, but it the court notes that "the facts present a close question." Despite the cours interpretation, this issue may not have been as close of a question as the court states.
What is absent from the opinion is whether the taxpayer claimed or tried to claim business expenses for his time as an independent contractor for MetLife or unreimbursed employee expenses for the period when he was an employee of MetLife. If the taxpayer had listed some business expenses it would most likely have been litigated (and a part of the court opinion), as the IRS was arguing that the taxpayer was paid as an employee by MetLife for at least part of the time the taxpayer was affilated with MetLife. It is hard to believe that the taxpayer did not incur some tax deductible expenses during this time - even if it was just training or home office expenses.
The court opinion also does not specify when the IRS notice of deficiency was issued (which is very unusual and -- in my mind, suspicious -- for a published Tax Court opinion), but the opinion does say that the tax year in question was 2002. The opinion was issued in mid-2006. Thus, it appears that the taxpayer should have been able to file an amended return for 2002 to claim the additional business expenses at the time when the IRS first notified the taxpayer of its position. These additional deductions may very well have offset any tax that resulted from the taxpayers MetLife proceeds being counted as income.
Had the taxpayer raised this issue during the IRS audit, the IRS agent may very well have just made the adjustments and the agent might not have even raised or even conceded the other issues that were litigated. In that case the taxpayers probably would not have had to resort to litigation, saving them the time, cost and brain damage that results from even simple tax litigation. Unfortunately these taxpayers, according to the court opinion, opted to represent themselves.
Of course I do not know if these particular taxpayers had additional deductible expenhses, but I see these types of scenarios time and time again. Specifically, I often encounter scenarios where it is apparent that an IRS agent is aware of a perfectly legal and obvious way that the taxpayer can reduce their tax liability to a point where they owe nothing or where they are entitled to a refund, but the agent opts not to alert the taxpayer to the proper tax reporting method but instead opts to pursue the taxpayer for other items of unreported or under-reported income.
The general rule is that failure to receive a Form 1099 is not necessarily "reasonable cause" for failure to report income. As a result, taxpayers who do not receive Form 1099's are generally are liable for penalties and interest on the unreported 1099 income. Regrettably, there are a number of court cases that support this conclusion. There are also a few court cases where the court found that the taxpayer was not liable penalties and interest that resulted from unreported 1099 income.
Mabinuori v. Commissioner is one such case. In that case the taxpayer employed by MetLife. He was first hired by MetLife as an independent contractor and subsequently hired as an employee. As such, MetLife had issued the taxpayer a Form W2 for his wages as an employee and a Form 1099-Misc for his non-employee earnings.
The court found the fact that MetLife had mailed the 1099 to the taxpayer's prior address and the W2 to the taxpayer's current address significant. Also, the court found that the taxpayer may have reasonably believed that part of his MetLife income was reimbursement for costs of setting up an office.
The court sides with the taxpayer on this issue, but it the court notes that "the facts present a close question." Despite the cours interpretation, this issue may not have been as close of a question as the court states.
What is absent from the opinion is whether the taxpayer claimed or tried to claim business expenses for his time as an independent contractor for MetLife or unreimbursed employee expenses for the period when he was an employee of MetLife. If the taxpayer had listed some business expenses it would most likely have been litigated (and a part of the court opinion), as the IRS was arguing that the taxpayer was paid as an employee by MetLife for at least part of the time the taxpayer was affilated with MetLife. It is hard to believe that the taxpayer did not incur some tax deductible expenses during this time - even if it was just training or home office expenses.
The court opinion also does not specify when the IRS notice of deficiency was issued (which is very unusual and -- in my mind, suspicious -- for a published Tax Court opinion), but the opinion does say that the tax year in question was 2002. The opinion was issued in mid-2006. Thus, it appears that the taxpayer should have been able to file an amended return for 2002 to claim the additional business expenses at the time when the IRS first notified the taxpayer of its position. These additional deductions may very well have offset any tax that resulted from the taxpayers MetLife proceeds being counted as income.
Had the taxpayer raised this issue during the IRS audit, the IRS agent may very well have just made the adjustments and the agent might not have even raised or even conceded the other issues that were litigated. In that case the taxpayers probably would not have had to resort to litigation, saving them the time, cost and brain damage that results from even simple tax litigation. Unfortunately these taxpayers, according to the court opinion, opted to represent themselves.
Of course I do not know if these particular taxpayers had additional deductible expenhses, but I see these types of scenarios time and time again. Specifically, I often encounter scenarios where it is apparent that an IRS agent is aware of a perfectly legal and obvious way that the taxpayer can reduce their tax liability to a point where they owe nothing or where they are entitled to a refund, but the agent opts not to alert the taxpayer to the proper tax reporting method but instead opts to pursue the taxpayer for other items of unreported or under-reported income.
 
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1 Comments:
Sometimes "what's not brought up" is the misinformation the IRS itself brings to the playing field.
According to a June 2006 Government Accounting Office (GAO) report, http://www.gao.gov/new.items/d06603.pdf "... 38 percent of individual taxpayers with securities transactions misreported their capital gains or losses..." and goes on to suggest that "expanding the information brokers report on securities sales to include adjusted cost basis has the potential to improve taxpayers' compliance ..."
When the IRS simply reports total-proceeds-received from broker-reported 1099s without regards to cost-basis, they themselves are contributing to the so-called tax-gap, as such same taxpayers scramble for their missing 1099s and go on to complete 1040X amended returns.
Rarely are 1099 proceeds coming from a basis of $0.00, and many times a missing 1099 will reveal a taxpayer's loss when compared to original purchase prices paid.
Perhaps this is why the "... court found that the taxpayer was not liable penalties and interest that resulted from unreported 1099 income ..." since when missing 1099s fnally show up and are compared to cost-basis, a much smaller gain, as compared to a cost-basis of $0.00, or many times even a "loss" and not a gain is the final end result.
I have yet to see a Government report acknowledging their part in the tax-gap from their own efforts to collect taxes in a forceful manner.
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