Line Items

The 1998 IRS Restructuring and Reform Act contained a taxpayers bill of rights. one provision expanded taxpayers’ due-process protections when dealing with collection matters: IRC section 6330 gives taxpayers the right to a “collection due-process” hearing in the IRS appeals office before a levy can be issued.

In Davis v. Commissioner, 115 TC no. 4 (2000), a taxpayer timely requested an appeals hearing, but his additional request to subpoena witnesses and documents was denied.

According to the Tax Court, hearings at the appeals level historically have been informal. The court could find nothing in IRC section 6330 or the legislative history of the 1998 act that suggested that Congress intended to change the informal nature of these hearings.

Error on 1999 Form 1040 PC May Trigger IRS Letter

Some taxpayers that used the form 1040 PC format to report their 1999 capital gains have received letters from the IRS saying they owe additional taxes.

These taxpayers received capital gain distributions from a mutual fund that were subject to the maximum tax rate of 20%. If the taxpayers included these distributions on line 13 of form 1040 and checked the accompanying box, they did not have to file schedule D.

However, form 1040 PC, as originally issued, did not include this box. So if a taxpayer used old return preparation software to report 1999 capital gains, he or she may have gotten a letter.

The IRS has said that it has no idea about how many taxpayers may be affected. If you or your client received a letter, you should either submit the information the service is requesting or file an amended return and treat the distribution as a long-term capital gain.

No Deduction for Homeowners’ Association Loan

The IRS ruled that an individual may not deduct the interest a homeowners’ association paid on a loan obtained to restore one of the common elements in the community. The regular and special homeowners’ assessments, a deed of trust on the common area and the homeowners’ dues secured the loan. One homeowner felt that since he was being assessed to pay off the loan he should be allowed to deduct the interest as qualified residence interest under IRC section 163(h)(2).

In LTR 200029018, the IRS said that because the homeowner’s principal residence wasn’t collateral for the loan and he had not undertaken any personal obligation on it, the interest deduction was denied.

No Summons Required for a Preparer

In a legal memorandum, the service said that an IRS employee—conducting an earned-income-credit due-diligence audit of a return preparer—does not have to provide a summons to the preparer to examine any documents that may be relevant or material to the inquiry of the preparer’s potential liability under IRC section 6695(g).

The service also advised that the preparer couldn’t refuse to provide the information based on the tax advice privilege under IRC section 7525. According to the memorandum, the attorney-client privilege under IRC section 7525 pertains to tax advice only and not to return preparation advice (LTR 200029008).

When an IRA Transfer Isn’t a Transfer

Under IRC section 408(d)(6), the transfer of an individual’s interest in an IRA to his spouse or former spouse under a divorce or separation instrument is not a taxable event. However, in order for it to be tax-free, the transfer must actually go to the spouse or former spouse.

In Jones v. Commissioner, TC Memo 2000-219, the taxpayer owned an IRA, which he gave to his wife in a divorce settlement agreement. However, instead of changing the account to his wife’s name or transferring the funds to her IRA, he had a check issued to himself for the entire account balance, which he endorsed over to his wife.

The IRS said that the check amount was currently taxable to the husband plus a 10% penalty for early withdrawal because he transferred cash and not the IRA to his wife.

The Tax Court agreed with the service and ruled that the endorsement of the check was not a transfer of his interest in the IRA because his interest was extinguished when he withdrew the funds.

Mixing Apples and Dentistry

A dentist and his wife operated a dental practice. They also maintained an apple orchard. The dentist recommended that his patients eat apples, and he and his wife sold their apples to the patients. On their federal income tax return, the couple attempted to offset the losses from the apple orchard against earnings from the dental practice.

The IRS stated that the apple orchard lacked a genuine profit motive, and the Ninth Circuit Court of Appeals agreed. According to the court, the apple orchard and the dental practice were separate activities, which could not be aggregated. The loss relating to the apple orchard was denied because IRC section 183 limits the deductibility of business activity losses to for-profit activities ( Zdun v. Commissioner, CA-9; July 5, 2000).

An IRA of Her Own

A couple filed for divorce and, as part of the settlement, the husband agreed to give a portion of his IRA to his former spouse. According to IRC section 408(d)(6), this trustee-to-trustee transfer is tax-free. The husband, although he was under 5912 years old, had already begun receiving substantially equal periodic payments without incurring penalties.

The former wife asked whether she would have to continue to withdraw substantially equal periodic payments from the IRA. The IRS said that since the IRA was now hers, she was not required to continue the withdrawals (PLR 200027060).

Couple Charged With Filing False Returns and Fraud

A pharmacist was president, sole shareholder and an employee of a company that operated two pharmacies. His wife kept the books for the company. However, an independent accounting firm prepared the corporate tax returns and the couple’s individual returns.

To record the company’s cash receipts and disbursements, the accounting firm gave the couple worksheets, which included a column for personal cash withdrawals.

The couple failed to record substantial amounts of personal cash payments. They did not disclose these unrecorded withdrawals to the accounting firm.

An IRS auditor was unable to reconcile the worksheets to the bank statements. So the audit was expanded to include the couple’s joint tax returns.

The couple were indicted and convicted of two violations of IRC section 7206(1) for filing false income tax returns. They conceded the unreported income issue, but contested the additional taxes for fraud and substantial understatement of tax.

The Tax Court found clear and convincing evidence of fraud on the couple’s part because they (1) understated their income, (2) maintained inadequate records, (3) gave implausible or inconsistent explanations and (4) had an intent to mislead ( Philip E. Parsons v. Commissioner, TC Memo 2000-205).

—Michael Lynch, Esq., professor of tax accounting at
Bryant College, Smithfield, Rhode Island.