Make up your mind! A Georgia investment broker finally got around to filing his 2001 in April 2003. He presented his preparer with an unusual deduction, according to a Tax Court case yesterday (my emphasis):
The return was prepared by a certified public accountant (C.P.A.). On Schedule E, Supplemental Income and Loss, petitioner claimed a flowthrough loss of $516,609 from MCM. Although MCM did not report a loss on its Form 1120S, U.S. Income Tax Return for an S Corporation, petitioner claimed a loss deduction of $554,622 on his own tax return and applied it against the $38,013 of passthrough income he reported from MCM. The deduction was characterized in a statement attached to petitioner’s 2001 return as “General Partner Expenses paid to reimburse”.
Petitioner claimed the deduction for payments he allegedly made to his clients to reimburse them for their losses in the hedge funds. Petitioner did not provide any detailed information or documentation about these payments to the C.P.A. who prepared his return. He simply told the C.P.A. to use the $554,622 expense on his 2001 income tax return.
There’s already a lot wrong here. You can’t pay deductions on behalf of an S corporation you own and deduct them on Schedule E. At best, such payments are miscellaneous itemized deductions, which must exceed 2% of AGI and do no good in computing alternative minimum tax. Only the actual K-1 amounts hit your Schedule E.
The mismatch between the K-1 and the Schedule E would attract IRS attention, even if filing almost a year late didn’t. But the facts made things worse:
Ten days after petitioner filed his 2001 return, he submitted a different version of the return to a bank while applying for a loan. This version omitted the $554,622 deduction petitioner claimed on his filed tax return.
That sort of things is bad for making friends at both the IRS and the bank.
The taxpayer told the Tax Court that the deductions weren’t fraudulent; they were just claimed in the wrong year:
Petitioner concedes that the deduction should not have been claimed for 2001. Instead, on his amended return petitioner claims his income for 2001 was fully offset by a net operating loss carryback from 2002 and 2003.
Unfortunately, the taxpayer failed to convince the tax court that there really were NOLs: “Petitioner has not provided any evidence of a net operating loss for 2002 or 2003, and we have no way of determining from the record whether a net operating loss was available for these years.” The Tax Court was reluctant to take the broker at his word. This might explain the reluctance:
On November 3, 2006, as litigation with these clients was pending, petitioner voluntarily filed a petition with the U.S. Bankruptcy Court for the Northern District of Florida under 11 U.S.C. chapter 7, No. 06-50298-KKS. During the bankruptcy proceedings petitioner failed to report numerous assets on his bankruptcy schedules, including two boats, a Harley Davidson motorcycle, investment accounts, and $40,000 of artwork.
On October 21, 2008, petitioner was indicted in the U.S. District Court for the Northern District of Florida on 23 counts of criminal misconduct. United States v. Reinhard, No. 4:08-Cr-00049-RH-CAS (N.D. Fla. filed Oct. 21, 2008). On May 13, 2009, petitioner pleaded guilty to seven counts of the indictment, including: (1) making false statements on his 2001 and 2002 income tax returns, in violation of section 7206(1); (2) making false statements on a loan application, [*5] in violation of 18 U.S.C. sec. 1014; and (3) transferring assets and concealing them from the bankruptcy trustee, in violation of 18 U.S.C. sec. 152(7).
Petitioner admitted as part of his plea agreement that he “included as part of his return a fraudulent Schedule E expense of $554,622”. Therefore, petitioner had admitted to fraud and is liable for the civil fraud penalty under section 6663(a) for the 2001 tax year.
When he filed his original 2001 tax return in 2003, petitioner was aware that the payments he reported would have been made in 2002 or 2003, not in 2001. Yet he directed his C.P.A. to claim a deduction for the payments for 2001 without any explanation. Petitioner is an intelligent and well-educated businessman, and we find that he knew that a cash method taxpayer can claim a deduction for an expense only for the year in which it is paid.
The Moral? Aside from the obvious “don’t commit fraud” lesson, we can learn from some simple but egregious mistakes:
– Timing matters. You can only deduct cash-basis deductions in the year of payment.
– If you want to deduct an S corporation expense, have the S corporation make the payment. You can’t pay corporate expenses personally and expect to deduct them as Schedule E expenses.
– If you want to deduct an expense, keep the documentation. The Tax Court never mentioned any settlement or other document showing that the broker had agreed to reimburse losses. If such an agreement existed, showing it to the Tax Court might have helped a great deal.
Cite: Reinhard, T.C. Memo 2015-116.
Jeffrey R. Gottleib, IRS Issues Final Regulations for Estate Tax Portability Elections. “When in doubt — file it!”
Jack Townsend, Julius Baer Reserves $350 Million for U.S. Tax Investigation. Swiss bank secrecy isn’t working out too well.
TaxProf, TIGTA: IRS Violated Federal Law By Awarding Millions In Contracts To Businesses With Unpaid Federal Taxes. Anybody expect that the lawbreakers will face any penalty at all?
Scott Greenberg, Investment Donations and the Charitable Deduction (Tax Policy Blog). “Out of the $42.91 billion of noncash donations reported on Form 8283, $22.07 billion were contributions of corporate stocks, mutual funds, and other investments.”
Gene Steurle, How to Pay Zero Taxes on Income of Millions of Dollars (TaxVox). Roth IRAs are involved.
News from the Profession. KPMG Gives Employees Enough Ice Cream to Last Them a Week (Caleb Newquist, Going Concern)
TaxProf, The IRS Scandal, Day 777:
IRS employees erased computer backup tapes a month after officials discovered that thousands of emails related to the tax agency’s tea party scandal had been lost, according to government investigators.
The investigators, however, concluded that employees erased the tapes by mistake, not as part of an attempt to destroy evidence.
Kids, don’t count on the “innocent mistake” excuse if you are thinking of destroying evidence they want.