IRS did not concede taxpayer’s self-employment tax liability

The Tax Court held that the IRS had not conceded a taxpayer’s liability for self-employment tax on freelance writing and memorabilia sales income by sharing information with the Social Security Administration (SSA) or by issuing a refund reflecting the effect of a delayed litigation hold. The court also sustained the IRS’s imposition of an accuracy-related penalty under Sec. 6662(a) for an underpayment due to a substantial understatement of income tax.

Facts: James Clark began working as a freelance writer in 1995 and had been selling movie-related memorabilia since at least 2019. He earned $8,250 from freelance movie review writing and $41,972 from memorabilia sales in 2019. PayPal reported the $41,972 payment on Form 1099-K, Payment Card and Third Party Network Transactions, with no federal income tax withheld.

On his 2019 federal income tax return, prepared with assistance from H&R Block, Clark did not report his freelance writing or memorabilia sales income on Schedule C, Profit or Loss From Business (Sole Proprietorship). Instead, he reported the amounts as “other income” not subject to self-employment tax on line 7a and claimed the standard deduction. Based on this, he reported and paid an income tax liability of $4,369.

In July 2020, the IRS processed Clark’s $4,369 payment. The following month, the IRS assessed a $134 penalty for failure to pay estimated tax (plus $4 of interest), which Clark paid in August 2021. In June 2021, the IRS’s Automated Underreporter (AUR) Program issued Clark a Notice CP2000 proposing changes to his 2019 return based on unreported payments on third-party information returns, including the Form 1099-K from PayPal. After Clark failed to respond, the IRS issued a notice of deficiency in November 2021, stating that the $50,222 he reported as other income was subject to self-employment tax and that he was liable for the penalty under Secs. 6662(a) and (b)(2) for a substantial understatement of income tax.

Clark timely petitioned the Tax Court in July 2022. However, because the IRS did not become aware of the petition until August 2022, it did not place a litigation hold on Clark’s IRS account. In March 2022, approximately four months before the IRS was served with Clark’s petition, it assessed the deficiency and penalty, together with interest. Then, in 2023, the IRS reversed the premature assessment and issued a $2,886 refund for 2019 related to amounts paid for failure to pay estimated tax and federal income tax withheld on other sources of income, among other payments and credits.

Additionally, before Clark’s case was calendared for trial, the SSA sent him a letter stating that, based on information provided by the IRS, it was reducing the self-employment income on his Social Security earnings record to zero for tax year 2019.

Issues: The two issues before the court were whether Clark was liable for (1) self-employment tax on his 2019 freelance writing and memorabilia sales income, and (2) an accuracy-related penalty under Sec. 6662(a) on an underpayment due to a substantial understatement of income tax.

Sec. 1401 imposes a tax on the self-employment income of individuals. Self-employment income is defined as “the net earnings from self-employment derived by an individual” (Sec. 1402(b)). Net earnings from self-employment is defined as “the gross income derived by an individual from any trade or business carried on by such individual, less the deductions … which are attributable to such trade or business” (Sec. 1402(a)).

The court found that, as an initial matter, the record established that Clark was self-employed as a freelance writer and memorabilia seller in 2019. Clark argued that he was not liable for self-employment tax because the IRS had conceded his liability for self-employment tax, citing the IRS’s reversal of its premature assessment and the SSA’s letter.

After drawing significant parallels between Clark’s case and Ashford, T.C. Memo. 2022-101, aff’d, Nos. 22-2307 et al. (4th Cir. 7/27/23), the court stated it was not convinced by Clark’s argument. In Ashford, the taxpayer received a similar SSA letter reducing his self-employment Social Security earnings to zero based on information provided by the IRS. As in Clark’s case, the SSA letter was found to result from a premature assessment and subsequent reversal rather than a substantive determination. The court in Ashford went on to hold that the IRS had not made a concession, reasoning that because the taxpayer had stipulated the amount and characterization of the income he received, his argument conflicted with the stipulated facts and hence had no merit.

Applying this analysis to Clark’s case, the court noted that Clark also did not dispute his receipt of the payments for his freelance writing or memorabilia sales. The court thus rejected Clark’s argument claiming an IRS concession as to the taxability of his income because it was “contrary to the evidence.” Further, the court was not persuaded that the refund issued for 2019 was a concession by the IRS, as it was issued to bring Clark’s account “into the proper status given the instant litigation, i.e., to reflect the effects of the delayed litigation hold, including the IRS’s reversing the premature assessment.” Thus, the court held that Clark was liable for self-employment tax on his freelance writing and memorabilia sales income.

The remaining issue for the court to resolve was whether Clark was liable for an accuracy-related penalty on his underpayment. Sec. 6662(a) imposes a 20% accuracy-related penalty on an underpayment required to be shown on a return if it is attributable to any substantial understatement of income tax. An understatement is substantial if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000 (Sec. 6662(d)(1)(A)). In general, the IRS bears the burden of production with respect to the accuracy-related penalty (Sec. 7491(c)).

The court found that the IRS had met its initial burden of production to show that Clark’s understatement was substantial because the record established that the understatement exceeded the greater of 10% of the tax required to be shown on the return or $5,000. And because the penalty was automatically calculated through electronic means by the IRS’s AUR program, it was exempt from the written-supervisory-approval requirement under Sec. 6751(b)(2)(B) (see Walquist, 152 T.C. 61 (2017)).

To avoid the penalty, Clark therefore had to prove through persuasive evidence that the penalty determination was incorrect. Sec. 6664(c)(1) provides that no penalty shall be imposed under Sec. 6662 if the taxpayer can show reasonable cause for the underpayment and that the taxpayer acted in good faith. This determination is based primarily on the extent of a taxpayer’s efforts to properly assess their tax liability (Regs. Sec. 1.6664-4(b)(1)). The court may also consider other pertinent facts and circumstances, including whether a taxpayer’s experience, education, and sophistication may have caused an honest misunderstanding of fact or law (id.; Higbee, 116 T.C. 438, 449 (2001)). Moreover, relying on professional advice may show reasonable cause and good faith if, in the light of all the facts and circumstances, such reliance was indeed reasonable and the taxpayer acted in good faith (id. at 448—49).

The court observed that although Clark’s sophistication regarding federal income tax matters was limited, he had been self-employed for over 30 years and routinely paid estimated tax penalties, indicating awareness of his tax obligations. In addition, the court explained that having a return prepared by H&R Block by itself does not show actual reliance on advice from a tax professional during the preparation process. Because Clark did not present persuasive evidence of a “cognizable effort to assess his proper tax liability or reasonable cause for the error,” the court sustained the accuracy-related penalty.

Holding: The Tax Court held that Clark was liable for self-employment tax on his income from freelance writing and memorabilia sales, as the IRS had not conceded his liability for the tax when it issued a refund reversing its premature assessment or when it shared information with the SSA. Accordingly, the court sustained the accuracy-related penalty on an underpayment due to a substantial understatement of income tax.

• Clark, T.C. Memo. 2025-13

— Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy at Cornell University; John McKinley, CPA, CGMA, J.D., LL.M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business at Cornell University; and Luke Richardson, CPA, J.D., is an associate professor of instruction and Kerkering Barberio fellow in accounting and taxation in the Muma College of Business at the University of South Florida. To comment on this column, contact Paul.Bonner@aicpa-cima.com, the JofA‘s tax editor.