Tax Update For Week of Nov. 28th through Dec. 4th

Tax Court

Wife of Convicted White Collar Criminal Denied Innocent Spouse Relief

Taxpayer-Wife sought relief from joint liability originating in part from Taxpayer-Husband’s embezzlement of funds from a church for which he was convicted of fraud, identity theft and tax evasion . The Tax Court upheld the IRS’s determination that Taxpayer-Wife was not eligible for innocent spouse relief under either § 6015(b), (c), or (f). The opinion noted several key facts that precluded relief: (1) a portion of the understatements were attributable to Petitioner-Wife’s unreported income items (unemployment compensation, legal fees, or interest income); (ii) she had knowledge or reason to know of the understatements at the time she signed the return because she was sophisticated (trained as an attorney) and had access to the joint accounts in which Taxpayer-Husband deposited the funds from his illegal activities; (3) she failed to timely pay her 2011 tax liability and understated her 2013 liability, which the court believed demonstrated that she had not made a good faith effort to comply with income tax laws following the years in issue.

Cite: Reynolds v Commissioner, T.C. Memo 2022-115 | Link

Tax Court Upholds IRS’s Denial of Foreign Business Losses on Schedule C

The Tax Court sustained the IRS’s denial of deductions for losses associated with a Malaysian business claimed by the taxpayers on schedule C. The Tax Court agreed with the IRS that the taxpayers had failed to demonstrate that they had an ownership interest in the Malaysian entity operating the business. The Tax Court also determined that the entity, organized under Malaysian law (a Sendirian Berhad; private limited liability company), was a “foreign eligible entity” for which the taxpayers had not made an election under the check-the-box regulations. Therefore, by default, the entity was treated as a corporation for federal income tax purposes and the owners could not claim losses from the business on Schedule C.

Cite: Ismail v Commissioner, T.C. Memo. 2022-113 | Link

Settlement Officer Abused Her Discretion for Failure to Follow-up With Taxpayer for Requested Financial Information During Work from Home Order

The Tax Court held that an IRS settlement officer abused her discretion by sustaining a collection action (levy) for taxpayer’s failure to supply financial information to analyze his ability to pay to establish an installment agreement. The settlement officer believed that the taxpayer failed to provide the information. However, she failed to follow-up with the taxpayer for the requested financial information while the settlement officer was working remotely (i.e., during an IRS work from home directive). The Taxpayer testified that he provided the requested financial information. The Tax Court found his testimony credible, even though the Taxpayer did not keep a copy. The Tax Court also took judicial notice of various reports by the IRS, the Treasury Inspector General for Tax Administration, the Taxpayer Advocate, and the Government Accountability Office regarding the IRS’s work from home order and the IRS’s delays with processing mail. The Court noted that given the circumstances, it was unreasonable for the settlement officer to close the taxpayer’s case without following up with him about the missing information. The Tax Court remanded the case to Independent Office of Appeals.

Cite: Ryan Michael Sterling v Commissioner, Docket no. 10995-21L, (Bench Op)((Nov. 30, 2022)| Link

IRS Guidance and Rulings

IRS Issues Ruling on Inadvertent S Corp Termination Due to Partnership Provisions in Operating Agreement

In PLR 202247004, a company elected to be treated as an S corporation. Subsequently, the owners entered into an amended and restated operating agreement, which included partnership tax provisions (maintenance of capital accounts and liquidating distributions in accordance with capital accounts).

As a result, the corporation had ceased to be treated as an S corporation because the partnership tax provisions violated the one class of stock rule (i.e., stock in an S corporation must confer identical rights to distributions and liquidation proceeds).

Upon learning of the issue, the company entered into another amended and restated operating agreement to remove the partnership tax provisions. However, the only way to nullify the S corporation termination was to request the IRS to issue a private letter ruling. Private letter rulings usually require a hefty filing fee and professional fees to draft the ruling request.

The IRS issued the ruling, which held that the termination was inadvertent and the company was able to maintain its S corporation status. However, the mistake likely cost the company significant time and expense to obtain relief.

Cite: IRS PLR 202247004 (Nov. 25, 2022) | Link

Other Tax News

TIGTA Releases Report on NRP Tax Return Selection for 2017 and 2019

In July 2022, a news story from the New York Times emerged that the IRS selected two high ranking public officials (James Comey and Andrew McCabe) for National Research Project examinations. The IRS only conducted ~4,000 such examinations for the years in question. Given the relatively low statistical probability of any individual being selected randomly, there was speculation that perhaps their selection was not random and was instead due to pressure from former President Trump. “At the request of the Commissioner of Internal Revenue and representatives from Congress, TIGTA’s Office of Inspections and Evaluations, initiated a review to determine if the IRS randomly selected individual income tax returns for Tax Years 2017 and 2019 NRP audits.”

The TIGTA report did not identify any misconduct. During their review, TIGTA was able to replicate most of the random selection process, but, much like a financial statement audit, the report did not provide positive assurance that no misconduct took place. TIGTA is taking additional steps to assess one step in the tax return selection process.

Cite: National Research Program Tax Return Selection Process for Tax Years 2017 and 2019, Treasury Inspector General for Tax Administration, Reference No. 2023-IE-R002, dated Nov. 29, 2022 | Link

.