SCOTUS Reports

Tag: Section 6662(a)

  • Alvin E. Keels, Sr. v. Commissioner of Internal Revenue, T.C. Memo. 2020-25: Substantiation of Deductions and Tax Treatment of Deferred Compensation

    Alvin E. Keels, Sr. v. Commissioner of Internal Revenue, T. C. Memo. 2020-25 (U. S. Tax Court, 2020)

    In a ruling by the U. S. Tax Court, Alvin E. Keels, Sr. faced a mixed outcome regarding his tax deductions and income reporting for 2012-2014. The court upheld the IRS’s disallowance of most of Keels’ claimed deductions due to insufficient substantiation, except for specific contract labor expenses. Additionally, Keels was not taxed on deferred compensation from State Farm, as the IRS failed to prove these amounts were taxable under Section 409A. The court also confirmed Keels’ liability for late filing penalties and accuracy-related penalties for substantial understatements of income tax.

    Parties

    Alvin E. Keels, Sr. , the Petitioner, represented himself (pro se). The Respondent was the Commissioner of Internal Revenue, represented by Timothy B. Heavner and Robert J. Braxton.

    Facts

    Alvin E. Keels, Sr. , an independent State Farm agent since 1985, filed tax returns for the years 2012, 2013, and 2014. Keels reported various business expenses on his Schedule C and claimed deductions for these expenses. He also participated in State Farm’s nonqualified deferred compensation program, which included termination and extended termination payments. In 2014, Keels used a PayPal account for the Jazz Legacy Foundation (JLF), a non-profit he was involved with, to receive payments for ticket sales to a fundraiser. The IRS issued a notice of deficiency, disallowing most of Keels’ claimed deductions and asserting that certain amounts were taxable income, including the yearend balances of his deferred compensation account and payments received via PayPal.

    Procedural History

    The IRS issued a notice of deficiency to Keels for the tax years 2012, 2013, and 2014, determining deficiencies in income tax and asserting additions to tax and penalties. Keels filed a petition with the U. S. Tax Court contesting the IRS’s determinations. The court held a trial, after which it issued its opinion. The IRS conceded some deductions but maintained its position on others, including the tax treatment of Keels’ deferred compensation under Section 409A, which was raised for the first time in its posttrial brief. The court applied the de novo standard of review for factual findings and legal conclusions.

    Issue(s)

    Whether Keels substantiated his claimed deductions beyond those conceded by the IRS?

    Whether the yearend values of Keels’ termination and extended termination payments from State Farm’s deferred compensation program were taxable income for the years at issue?

    Whether Keels had $167,223 of income from PayPal, Inc. , for 2014?

    Whether Keels is liable for additions to tax for failure to timely file under Section 6651(a)(1) and accuracy-related penalties under Section 6662(a) for the years at issue?

    Rule(s) of Law

    Section 6001 of the Internal Revenue Code requires taxpayers to maintain records sufficient to establish the amount of any deduction claimed. The burden of proof generally rests with the taxpayer to substantiate deductions (Rule 142(a), Tax Court Rules of Practice and Procedure). Section 409A addresses the tax treatment of nonqualified deferred compensation plans, requiring specific conditions to be met to avoid immediate taxation. Section 6651(a)(1) imposes an addition to tax for failure to timely file a return unless the taxpayer shows reasonable cause. Section 6662(a) and (b)(2) impose an accuracy-related penalty for substantial understatements of income tax, with an exception if the taxpayer acted with reasonable cause and in good faith.

    Holding

    The court held that Keels substantiated specific contract labor deductions but failed to substantiate most other claimed deductions. The yearend values of Keels’ termination and extended termination payments were not taxable income for the years at issue, as the IRS did not meet its burden of proof under Section 409A. The $167,223 received via PayPal in 2014 was not income to Keels, as it belonged to JLF. Keels was liable for additions to tax under Section 6651(a)(1) for late filing and accuracy-related penalties under Section 6662(a) for substantial understatements of income tax.

    Reasoning

    The court found that Keels did not meet his burden of proof to substantiate most of his claimed deductions, as he failed to provide receipts, invoices, or other documentation showing the purpose of his expenses. His testimony was deemed insufficiently credible. Regarding the deferred compensation, the IRS bore the burden of proof due to its late assertion of Section 409A as a basis for taxation. The IRS failed to provide evidence that the State Farm plan did not meet Section 409A requirements or that there was no substantial risk of forfeiture. The PayPal receipts were not taxable to Keels, as they were for JLF’s activities. The court upheld the penalties for late filing and substantial understatements, finding no reasonable cause shown by Keels.

    Disposition

    The court’s decision was to be entered under Rule 155, reflecting the upheld deficiencies, the disallowed deductions, the nontaxability of the deferred compensation, the non-inclusion of PayPal receipts as income, and the imposition of penalties for late filing and substantial understatements.

    Significance/Impact

    This case underscores the importance of maintaining thorough records to substantiate tax deductions, as the court strictly applied substantiation requirements. It also highlights the procedural importance of timely raising legal theories in tax litigation, as the IRS’s late assertion of Section 409A led to the court’s finding that it bore the burden of proof, which it failed to meet. The decision reaffirms the application of penalties for late filing and substantial understatements, emphasizing the need for taxpayers to demonstrate reasonable cause to avoid such penalties.

  • Richard Essner v. Commissioner of Internal Revenue, T.C. Memo. 2020-23: Taxation of Inherited IRA Distributions and Section 7605(b) Examination Limits

    Richard Essner v. Commissioner of Internal Revenue, T. C. Memo. 2020-23 (U. S. Tax Court 2020)

    In Richard Essner v. Commissioner, the U. S. Tax Court upheld the IRS’s determination of tax deficiencies and penalties against Essner, a California cancer surgeon, for failing to report income from inherited IRA distributions in 2014 and 2015. The court rejected Essner’s claim that the IRS conducted an unnecessary second examination of his 2014 tax year, clarifying the scope of section 7605(b). This ruling underscores the necessity for taxpayers to accurately report inherited IRA distributions as income and the limited protections against IRS examinations under section 7605(b).

    Parties

    Richard Essner, the petitioner, represented himself pro se. The respondent, the Commissioner of Internal Revenue, was represented by Mark A. Nelson and Sarah A. Herson. The cases were consolidated under docket numbers 7013-17 and 1099-18 for trial and opinion.

    Facts

    Richard Essner, a cancer surgeon residing in California, inherited an IRA from his late mother, who had inherited it from his father. Essner received distributions from the IRA of $360,800 in 2014 and $148,084 in 2015. He researched the tax implications of these distributions on the IRS website and concluded they were not taxable. Essner engaged a return preparer for his 2014 and 2015 returns but did not inform the preparer of the IRA distributions. Consequently, Essner did not report these distributions as income on his tax returns. The IRS, having received Forms 1099-R reporting the distributions, initiated two separate processes to address the discrepancies: the Automated Underreporting (AUR) program and an individual examination by Tax Compliance Officer Hareshkumar Joshi.

    Procedural History

    The IRS’s AUR program identified a discrepancy in Essner’s 2014 return and issued a notice of deficiency on January 3, 2017, for $117,265, which Essner contested by filing a timely petition with the U. S. Tax Court under docket No. 7013-17. Concurrently, Officer Joshi examined Essner’s 2014 and 2015 returns, focusing on other issues but not the IRA distributions. On October 23, 2017, the IRS issued another notice of deficiency for Essner’s 2015 tax year, determining a deficiency of $101,750 and an accuracy-related penalty under section 6662(a) of $20,350, which Essner also contested under docket No. 1099-18. The Tax Court consolidated the cases for trial and opinion.

    Issue(s)

    Whether Essner failed to report distributions from an inherited IRA as income for 2014 and 2015?

    Whether the IRS subjected Essner to a duplicative inspection of his books and records relating to his 2014 tax year in violation of section 7605(b)?

    Whether Essner is liable for the accuracy-related penalty under section 6662(a) for tax year 2015?

    Rule(s) of Law

    Section 61(a) of the Internal Revenue Code defines gross income as “all income from whatever source derived”, including income from pensions under section 61(a)(11). Section 7605(b) limits the IRS to one inspection of a taxpayer’s books of account per taxable year, unless the taxpayer requests otherwise or the Secretary notifies the taxpayer in writing of the need for an additional inspection. Section 6662(a) authorizes the imposition of a 20% accuracy-related penalty for substantial understatements of income tax, which can be excused if the taxpayer shows reasonable cause and good faith.

    Holding

    The Tax Court held that Essner failed to report the IRA distributions as income for 2014 and 2015, sustaining the IRS’s deficiency determinations. The court also held that the IRS did not violate section 7605(b) by conducting a second examination of Essner’s 2014 tax year, as the AUR program’s actions did not constitute an examination of Essner’s books and records. Finally, the court held Essner liable for the accuracy-related penalty for tax year 2015, finding that he did not act with reasonable cause and good faith.

    Reasoning

    The court reasoned that Essner’s failure to report the IRA distributions as income was not supported by any evidence that a portion of the distributions represented a non-taxable return of his late father’s original investment. Essner’s inability to substantiate his claim due to lack of records from financial institutions did not relieve him of his burden of proof. Regarding section 7605(b), the court narrowly interpreted the statute, concluding that the AUR program’s review of third-party information and Essner’s filed tax returns did not constitute an examination of his books and records. Therefore, no second examination occurred, and the IRS’s actions were not unnecessary. For the accuracy-related penalty, the court found that Essner’s failure to consult his return preparer about the IRA distributions, despite his professional background and the size of the distributions, demonstrated a lack of reasonable cause and good faith.

    Disposition

    The Tax Court entered decisions sustaining the IRS’s determinations of tax deficiencies for 2014 and 2015 and the accuracy-related penalty for 2015.

    Significance/Impact

    This case reaffirms the IRS’s authority to require taxpayers to report inherited IRA distributions as income and clarifies the limited scope of section 7605(b) in protecting taxpayers from multiple examinations. It also highlights the importance of taxpayers seeking professional advice to ensure accurate tax reporting, particularly in complex situations involving inherited assets. The decision may influence future cases involving similar issues of tax reporting and IRS examination practices, emphasizing the need for clear communication and coordination within the IRS to avoid confusing taxpayers.

  • Ugorji Timothy Wilson Onyeani v. Commissioner of Internal Revenue, T.C. Memo. 2020-15: Bank Deposits Analysis and Termination Assessments in Tax Law

    Ugorji Timothy Wilson Onyeani v. Commissioner of Internal Revenue, T. C. Memo. 2020-15 (U. S. Tax Court 2020)

    In a significant ruling, the U. S. Tax Court upheld a termination assessment against Ugorji Timothy Wilson Onyeani, finding he received unreported income of $802,083. The court applied a bank deposits analysis to reconstruct Onyeani’s income, despite uncertainties about the nature of his transactions. However, the court declined to impose civil fraud or accuracy-related penalties, as there was no underpayment of tax due to the termination assessment. This decision underscores the IRS’s authority to use bank deposits analysis in assessing income and the procedural nuances surrounding termination assessments and penalties.

    Parties

    Ugorji Timothy Wilson Onyeani was the petitioner, representing himself pro se. The Commissioner of Internal Revenue was the respondent, represented by Sarah E. Sexton Martinez, Eugene A. Kornel, and Megan E. Heinz.

    Facts

    In early 2015, Ugorji Timothy Wilson Onyeani incorporated American Hope Petroleum & Energy Corp. (AHPE) and received approximately $750,000 from entities allegedly interested in purchasing Nigerian crude oil. Onyeani attempted to wire $300,000 to a foreign bank account, prompting the U. S. Secret Service to alert the IRS. Suspecting Onyeani intended to flee the country or remove assets, the IRS conducted a bank deposits analysis and determined he received taxable income of $802,083 as of May 13, 2015. The IRS made a termination assessment under section 6851(a), assessed tax of $288,546, and collected it by levying Onyeani’s bank account after he unsuccessfully challenged the assessment in Federal District Court. Onyeani filed a 2015 tax return, reporting none of the income subject to the termination assessment. The IRS issued a notice of deficiency, determining unreported income of $802,083, a deficiency of $273,407, and penalties for civil fraud and accuracy-related issues.

    Procedural History

    Onyeani challenged the termination assessment and levy in the U. S. District Court for the Northern District of Illinois, which upheld the IRS’s actions as reasonable. The IRS then issued a notice of deficiency for the 2015 tax year, which Onyeani contested in the U. S. Tax Court. The Tax Court’s jurisdiction was affirmed as the notice was issued within 60 days of the due date of Onyeani’s 2015 return.

    Issue(s)

    Whether the IRS correctly determined that Ugorji Timothy Wilson Onyeani received unreported income of $802,083 for the 2015 tax year, and whether he is liable for civil fraud and accuracy-related penalties?

    Rule(s) of Law

    The IRS is authorized to use the bank deposits method to reconstruct a taxpayer’s income when records do not clearly reflect income. Section 6851(a) allows the IRS to make a termination assessment if it believes a taxpayer intends to leave the country or remove assets. Section 6663(a) imposes a civil fraud penalty if any part of an underpayment is due to fraud, and section 6662(a) imposes an accuracy-related penalty for underpayments due to negligence or substantial understatement of income tax. The IRS must meet its burden of production for penalties under section 7491(c) and prove fraud by clear and convincing evidence under section 7454(a).

    Holding

    The U. S. Tax Court held that the IRS correctly determined Onyeani received unreported income of $802,083 for the 2015 tax year, but reduced this by $400,000 due to a repayment to one of the entities involved. The court found no underpayment of tax due to the termination assessment and thus declined to impose civil fraud or accuracy-related penalties.

    Reasoning

    The court applied the bank deposits method to reconstruct Onyeani’s income, finding that the deposits into his accounts were prima facie evidence of income. The court disregarded AHPE as a separate taxable entity due to its lack of corporate formalities and Onyeani’s use of its funds for personal expenses. The court also considered the possibility that the funds were received illegally but noted that illegally received funds are taxable unless accompanied by an obligation to repay. Onyeani’s $400,000 repayment to LaSalle was offset against his gross income for 2015. The court rejected Onyeani’s claims for deductions due to lack of substantiation. Regarding penalties, the court found no underpayment of tax due to the termination assessment, and even if there were an underpayment, the IRS did not prove fraud by clear and convincing evidence. The court noted that Onyeani’s failure to report income on his 2015 return did not indicate an intent to evade taxes, given the pending litigation over the termination assessment.

    Disposition

    The court directed the parties to submit computations under Rule 155 to determine Onyeani’s final tax liability for 2015, reflecting the court’s findings.

    Significance/Impact

    This case reaffirms the IRS’s authority to use the bank deposits method to reconstruct income and highlights the procedural requirements for termination assessments and penalties. It underscores the importance of corporate formalities in distinguishing between corporate and personal income and the need for clear evidence of fraudulent intent to impose penalties. The decision may influence future cases involving termination assessments and the treatment of allegedly fraudulent income, particularly in contexts where the nature of transactions is uncertain.