IRS Practice and Procedure News Briefs for September 2017

REPORTING INCOME OF A MINOR – Lopez v. Commissioner, TC Memo. 2017-171 (2017)

Why This Case is Important: When a minor child earns income, that child’s parents may not understand the rules for reporting that income, or related expenses, to the IRS. This case discusses those rules.

Facts: In Lopez, the taxpayers’ daughter began competing in beauty pageants at the age of nine. In both 2011 and 2012, when she was still a minor, their daughter received over $1,000 in pageant winnings. The taxpayers incurred over $15,000 in expenses in each of these years related to their daughter’s competitions. When the child won a prize, checks were made payable to her and deposited into her college savings account. The taxpayers reported the income and expenses related to their child’s pageant competitions on Schedule C to the their federal income tax returns. The IRS examined these returns and disallowed the losses the taxpayers claimed related to the pageant competitions and issued notices of deficiency. The taxpayers filed a petition with the U.S. Tax Court contesting these notices.

Law and Analysis: Under Section 73(a) of the Internal Revenue Code, “amounts received in respect of the services of a child” must be included in the child’s own gross income, rather than that of the parents. Section 73(b) requires that all expenditures attributable to a child’s income under Section 73(a) be treated as having been paid by that child, such that only the child can deduct those expenses. That being the case, if the taxpayers’ child’s pageant income constituted “amounts received in respect of” her services, the taxpayers would not be permitted to deduct the related expenses. Based on previous case law, the Court stated that pageant winnings are treated as compensation for services. Because that compensation was paid based on the child’s performance, and with the prize money having been paid directly to the child, the Court held that the prize money was received with respect to her services, and therefore was includable in her income. Accordingly, the related expenses were deducible by her, not her parents. The Court found in favor of the IRS.

CLAIMS FOR REFUND ON UNFILED RETURNS – Borenstein v. C.I.R., 149 T.C. No. 10 (2017)

Why this Case is Important: Taxpayers who do not file their tax returns on time risk forfeiting their right to receive a tax refund. As this case demonstrates, based on some convoluted rules from the Internal Revenue Code, the IRS can proactively cutoff a taxpayer’s right to receive a tax refund by issuing a notice of deficiency prior to that taxpayer filing a past-due return.

Facts: In Borenstein, the taxpayer requested a filing extension with respect to her 2012 federal income tax return. By the time that request was submitted, she had paid a total of $112,000 against her 2012 income tax liability. She did not file her 2012 return by the extended due date. On June 19, 2015, the IRS issued a notice of deficiency asserting that she owed $1.6 million in tax for 2012. On August 29, 2015, the taxpayer filed her 2012 return, which reported a reduced tax liability of $80,000. The IRS determined that is was accurate. Based on that liability and the taxpayer’s previous payments, she had overpaid her liability by $32,000. The issue in this case was whether, in light of the taxpayer’s late filing of this return, she was entitled to a refund of this overpayment.

Law and Conclusion: When a notice of deficiency is issued to a taxpayer and the taxpayer files a Tax Court petition contesting that notice, whether an overpayment can be refunded to that taxpayer is governed by Section 6512(b) of the Internal Revenue Code. Under this section, when the notice of deficiency was issued prior the taxpayer filing a claim for refund (i.e., a tax return), the taxpayer is only entitled to a refund of amounts paid: (1) after the mailing of the notice of deficiency, or (2) within the two years prior to the taxpayer’s filing of the return. This two-year window is extended to three years where the notice of deficiency is sent in the third year after the return’s due date (with extensions). In this case, the taxpayer asserted that the notice of deficiency, which was issued in June 2015, was issued in the third year after the April 15, 2013 due date of the return, as the third year would have started April 16, 2015. The IRS argued that, as a result of the extension the taxpayer filed, the return was due October 15, 2013, and the third year did not start to run until October 16, 2015. Based on the language of the statute, the Court agreed with the IRS. That being the case, the taxpayer was only entitled to a refund of amounts paid within the two years prior to the issuance of the notice of deficiency, rather than three years. With the taxpayer not having paid any amount within that two year period, she was not entitled to a refund. By issuing the notice of deficiency prior to the taxpayer filing a tax return, the IRS essentially cutoff her right to receive a tax refund.

PROOF OF FILING EXTENSION – Laidlaw v. C.I.R., T.C. Memo. 2017-167 (2017)

Why This Case is Important: Taxpayers and tax preparers often filed tax return deadline extension requests without keeping any proof of filing and without using any form or registered, trackable mail. As this case demonstrates, this is not a good idea.

Facts: In Laidlaw, the taxpayers’ 2005 income tax return was prepared by their CPA. On April 17, 2016, according to the CPA, he prepared a request for extension of the deadline to file that return and submitted it to the IRS. However, the IRS claimed to have never received the request for extension. The return was filed on October 16, 2006. Upon receiving the return, the IRS assessed a penalty for the return not having been filed on time. The taxpayers filed a petition with the U.S. Tax Court contesting this assessment, among other issues.

Law and Analysis: Federal regulations provide individuals with automatic six-month extensions of the deadlines for filing their individual income tax returns if they (1) submit a complete application for extension on IRS Form 4868, (2) file the application by the deadline for filing the return with the IRS office designated in the application instructions, and (3) show the full amount properly estimated as tax for the taxable year. Under Section 7491 of the Internal Revenue Code, in a Tax Court proceeding related to the assessment of penalties, the burden of proof is on the IRS. Where the IRS meets its burden, the burden shifts to the taxpayer. By producing its own internal records indicating that no request for an extension had been received and that the return itself was not received until October 16, the Court found that the IRS met its burden with respect to the assessment of a late-filing penalty, thus shifting the burden to the taxpayers. Unfortunately for the taxpayers, they had no evidence to offer in support of the fact that their extension was filed timely other than the testimony of their CPA. Due to the time that had passed since the dates in question and the CPA’s loyalty to the taxpayers, the Court gave his testimony little weight. With no other evidence being offered, the Court found that the taxpayers did not meet their burden of proof and found in favor of the IRS, thereby upholding the penalty assessment.

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