IRS Error and Tax court

[Openfire]

I have a client that I am representing in Tax Court. The IRS denied an expense for mileage as the person was paid on a W-2, (self-prepared return--not my error) However, in the adjustments made by the IRS on the Examination Changes mailed to the client, they made an error. The IRS attorney has acknowledged the error, and has adjusted this amount of the additional tax charged. However, it is my argument that the charges for penalties and interest on the rest of the corrections should be dropped due to their error in the adjustments made by the IRS. Has anyone had any experience with this? I am trying to find precedence, but am having difficulty finding any.

[Koss]

Penalties & Interest

They won't waive the interest for any reason. The interest will be calculated only on the amount of tax due. The taxpayer could have paid the undisputed amount of the tax due at any time. You won't win that argument.

They may waive the penalties. But even the penalties should only be calculated based on the amount of tax due, i.e., the amount which your client appears to have conceded.

What type of penalty is it? Accuracy-related? 6662(a)?

How much money is involved? What is the amount of the additional tax, and how much is the penalty?

BMK

[Openfire]

Yes, accuracy related, and added on SE tax. I already had the SE tax corrected, because client was paid by W-2, and they are stating that he was indeed an employee. We are looking at 12,500 for tax, and an additional $2500 for accuracy. Now minus the 4600 for SE. I was really hoping to get below the $5000 for accuracy, so that would be waived as well.

[Koss]

Reasonable Cause

I remember this now from your earlier thread. The guy was paid on Form W-2, but used Schedule C to take the mileage expense.

Did he also report the income on Schedule C? That may be important, and I'm asking because that would explain why they added self-employment tax, which was then removed.

You can avoid the 20% accuracy-related penalty if you can show that the taxpayer had reasonable cause for the underpayment of tax. There is no simple way to determine whether reasonable cause existed. It is based on the facts and circumstances in each case. You have to show that the taxpayer acted in good faith. You can read the applicable treasury regulations here:

http://www.law.cornell.edu/cfr/text/26/1.6664-4

In your client's case, the fact that he did his own return, without professional advice, may help support an argument that he was acting in good faith.

On the specific facts of this case, your ability to persuade the IRS attorney to waive the penalties may hinge heavily on your client's education level.

If he is a tradesman with only a high school education, who really did not understand what the f**k he was doing, then you may have a pretty good shot. But if he has an MBA, then you're wasting your time. Of course, he's probably somewhere in between those two extremes. It's very subjective.

If he reported the amount in Box 1 on Form W-2 as gross receipts on Schedule C, then this tends to show that he was really clueless, because he was unwittingly subjecting himself to self-employment tax on earnings that had already been subjected to FICA withholding.

There is a lot of case law on the "reasonable cause exception" to the accuracy-related penalty. It always comes down to a very subjective and nuanced judgment call by the IRS, or, if you take the case to trial, by the Tax Court. In plain English, what they have to decide is: Should this guy have known better?

Even if your guy has a college education, you may be able to make an argument if he has little or no business experience, and if this was the first time that he ever went to work as a "government contractor."

I once handled a case in IRS appeals, and persuaded the appeals officer to waive the accuracy-related penalty, simply by explaining in a letter that the taxpayer was an immigrant whose first language was not English, and that he had only an eighth-grade education.

Unfortunately, your case sounds like it isn't quite that simple.

BMK

[Openfire]

Thank you so much for the information. I really wanted some supporting cases in which to refer. Thank you for your insight.

[Koss]

Case Law

There are lots of cases out there. But each case has peculiar facts. Many of them involve cases where the taxpayer relied on the advice of a tax professional, while others involve the question of whether the taxpayer has a reasonable explanation for failing to report income. In most cases, for example, even if you can prove that the taxpayer did not receive Form W-2, that's not going to cut it, because they know they received the income, and they know it is taxable. But see this thread for a link to a recent case in which the taxpayer managed to convince the Tax Court that they really forgot about a W-2:

http://forum.thetaxbook.com/showthread.php?23784-Substantial-Tax-Understatement-Penalty-Acceptable-Excuse

I don't think you're going to find a case that directly addresses what your client did, and whether he was acting in good faith. You could spend a lot of time searching for a case, and maybe find something similar, but not quite the same.

You may want to craft an argument by using the language of the Treasury Regulations. I found a very interesting article on Forbes that suggests that you should cite the Internal Revenue Manual:

http://www.forbes.com/sites/irswatch/2013/09/01/reducing-irs-penalties/

Have you actually talked with the IRS attorney in this case? Have you asked the guy if he would waive the penalties, because your client reasonably believed that he was self-employed, and he was acting in good faith?

BMK

[Koss]

Accuracy-Related Penalty

Openfire wrote:

We are looking at 12,500 for tax, and an additional $2500 for accuracy. Now minus the 4600 for SE.

If they have already agreed to reduce the tax from $12,500 to $7,900, then the penalty will automatically be reduced from $2,500 to $1,580, because the penalty is 20% of the underpayment of tax.

You may be able to get them to waive the penalty altogether, based on reasonable cause and good faith. But even if they don't, it will be automatically recalculated. If they have not acknowledged that, then either you are dealing with someone who isn't thinking clearly, or they don't understand the point that you are trying to address. The penalty is 20% of the tax.

If they reduce the tax due, the IRS software should automatically refigure the penalty and the interest.

BMK

[New York Enrolled Agent]

They won't waive the interest for any reason.

§6404 does provide for the abatement of interest under some certain circumstances including mathematical errors by the IRS.

[taxmandan]

On the specific facts of this case, your ability to persuade the IRS attorney to waive the penalties may hinge heavily on your client's education level.

>>If he is a tradesman with only a high school education, who really did not understand what the f**k he was doing, then you may have a pretty good shot. But if he has an MBA, then you're wasting your time. Of course, he's probably somewhere in between those two extremes. It's very subjective.
>snip
BMK

I would be more prone to think the MBA was clueless than the blue collar worker. ; )