Tax Court says you can’t go below zero. At least not in computing penalties.
A taxpayer filed a return showing no tax, but claiming refundable tax credits that generated a refund of $7,327. That’s why refundable credits are such a sweet deal — you can get a refund of taxes without ever paying them through withholding or estimated taxes. They are really a form of welfare.
The IRS issued the refund as claimed, but then thought better of it. The IRS recomputation was that the taxpayer should have showed a positive tax balance of $144. That meant the taxpayer was supposed to repay the $7,327 refundable credit plus the $144 tax due, for a total of $7,471. The IRS assessed the difference, plus a 20% penalty on the $7,471 “underpayment.” The taxpayer didn’t think refunding the refundable credit counted as an “underpayment, and the case went to Tax Court.
The tax imposes an “accuracy related” penalty on deficiencies, based on how much the taxpayer underpays the “tax required to be shown on the return.” The IRS said the underpayment was the whole $7,471. The Tax Court said that refundable credits can’t take the tax below zero for this purpose, so the “underpayment” is only $144 for computing the penalty.
This seems wrong. Refundable credit fraud — especially Earned Income Tax fraud — is a multi-billion-dollar problem. If there is no monetary penalty for claiming bogus credits, the only deterrent for gaming the system is criminal penalties, and given the limits on the IRS ability to prosecute EITC fraud, it’s an empty threat.
The Tax Court seems to agree:
We note that our conclusion breaks the historical link between the definitions of a deficiency and an underpayment; however, it was Congress that made that break.
If the case holds up on appeal, Congressional action is all that can fix it.
Cite: Rand, 141 T.C. No. 12.
I hate to spoil a nice celebration, but I am going to risk it. The position that the IRS outlined in the ruling is probably good news for most people affected by it. It may not be good news for everybody, though. In order to understand why you have to understand the IRS reasoning. Here is the deal. When debt is secured by property, it is either recourse or non-recourse…
The effect of that section is to make just about all California home mortgages non-recourse… There are various exceptions to recognizing debt discharge income, such as the insolvency exception. These will no longer be available.
When you give up a house for non-recourse debt, you are considered to sell it for that amount. That can be a bad thing. If you don’t qualify for the residential gain exclusion — say, because you haven’t used it as a residence long enough to qualify, or you bought the house to rent — you can have taxable gain, no cash, and no available debt forgiveness exclusion.
Alan Cole, High Implicit Marginal Tax Rates Make Life Difficult for the Poor (Tax Policy Blog):
The CBO did a great study on this a year ago. It found that the implicit marginal tax rates on some poor folk are frequently above 50%, and sometimes above 80%. That is to say, that when they figure out how to increase their income by a $100, they lose $50 or more in new taxes or lost benefits.
That’s exactly the sort perverse effect that results from the increase in Iowa’s earned income tax credit, which by itself can put low income taxpayers in a 50%+ bracket. Take away other benefits and you can see how it could get to 80% or more.
Sioux City Journal, Branstad declines to issue a gas tax veto threat. Probably because he’d like a higher gas tax, even though he likes being re-elected too much to push for one.
Ben Harris, Sorting Through The Property Tax Burden (TaxVox):
Using self-reported American Community Survey data, we find that residential property taxes tend to be close to $1,000 per year, with a small share of households paying substantially more, especially in Connecticut, New Jersey, New York and New Hampshire. In recent years, 48 percent of homeowners paid between $750 and $1,750 in property taxes. About one-third—31 percent—paid less than $750 and 21 percent paid more than $1,750. Just 3 percent paid more than $4,000, with a miniscule share of homeowners (0.2 percent) paying more than $8,000.
That seems low, but my clients probably aren’t a representative sample.
Jason Dinesen, Missouri Guidance on Same-Sex Marriage
The solution for tax preparers who didn’t want to register and pay the fee? They simply don’t sign the returns.
And yes, that’s against the rules. But a number of paid tax preparers do it anyway. They are referred to in the business as “black market preparers” or sometimes, “ghost” tax preparers.
And that will happen no matter what regulations the IRS imposes on honest preparers.
William Perez, Tax Provisions Expiring at the End of 2013
I really don’t expect to receive tips from clients–it’s not the norm for tax preparation. I definitely don’t expect to receive $1,458,905 in such gratuities.
TaxProf, The IRS Scandal, Day 194
Robert D. Flach brings the Tuesday Buzz!
The Critical Question: Are Jamaican Credit Unions The Next Tax Haven? (Brian Mahany)
AOL? Prodigy? Attorney’s License to Practice Law Is Suspended for Failing to Maintain an Email Account (TaxProf)
Tags: TaxProf, tax court, Russ Fox, Robert D Flach, TaxGrrrl, preparer regulation, Branstad tax policy, Peter Reilly, Anthony Nitti, EITC, The Critical Question, Brian Mahany, Ben Harris, Alan Cole, Judge Buch