Federal Income Tax Update
By This is the last of three installments of this article.
I. Bookkeeper Falls Victim to Section 6672 Trust Fund Recovery Penalty; Kazmi, TC Memo 2022-13.
In Kazmi, a bookkeeper was found liable for the Section 6672 trust fund recovery penalty. The facts of this case are particularly sad.
The bookkeeper, Mr. Kazmi, worked part-time at an hourly rate for an urgent care medical practice. He had no ownership interest in the practice, nor was he an officer or director. Mr. Kazmi was not listed as an authorized signatory on any of his employer’s bank accounts. He did not have any check signing authority nor any authority to direct payments to the employer’s creditors. Unfortunately, Mr. Kazmi did handle all payroll functions. Because he transmitted payroll tax returns and made federal tax deposits for his employer when he was aware withheld taxes had not been remitted to the IRS, he was responsible for the trust fund recovery penalty.
II. Section 6672 Penalties are Not Eligible for Section 6015 Innocent Spouse Equitable Relief; Chavis, 158 TC No. 8 (2022).
In Chavis, the Tax Court reminded us the Section 6672 trust fund recovery penalty is just that; a penalty and not a tax. Therefore, a spouse cannot assert an innocent spouse relief defense to assessment of the Section 6672 penalty.
In Chavis, the husband and wife were the owners of a corporation that fell behind in paying tax withholdings. The IRS determined both the husband and wife were responsible persons who were personally liable for the withheld taxes under Section 6672. However, the wife claimed the husband was more at fault than she, and she should be eligible for Section 6015(f) equitable innocent spouse relief for purposes of the Section 6672 penalty. However, the court held the Section 6672 trust fund tax is a penalty rather than an income tax to which the innocent spouse defense is available.
III. Private Duty Nurses are Employees for Employment Tax Purposes; Pediatric Impressions Home Health, TC Memo 2022-35.
Pediatric Impressions provides a good overview of the application of the Section 530 safe harbor relief and the twenty-factor common law employee test. Pediatric Impressions provided at-home private duty nursing services to children with special needs. Prior to 2016, the company treated the nurses as employees for federal employment tax purposes. Starting in 2016, the company began treating many of the nurses as independent contractors. However, the jobs and services performed by the nurses remained substantially the same. During the years at issue, the company did not make any federal employment tax deposits. The IRS assessed tax, interest and penalties for the company’s failure to make employment tax deposits.
The Tax Court sided with the IRS and held the nurses should have been characterized as common law employees. The company was not eligible for the Section 530 safe harbor relief. In addition to the company’s being liable for employment taxes and interest, it was liable for penalties under Section 6651(a)(1), failure to deposit penalties under Section 6656, and accuracy related penalties under Section 6662(a).
A. Legal Classification of Nurses as Employees. Based on the twenty-factor common law employee test, the court ruled the nurses were employees rather than independent contractors. There were many factors that weighed heavily against the company. The company informed the nurses they were employed on a full-time basis. The nurses were required to apply for jobs, undergo a background check, and complete a nursing skills assessment. Nurses were paid on an hourly rate based on their own timesheets. Although the company did not offer any employee benefits to the nurses, they were reimbursed for certain transportation expenses. The nurses were not expected to provide their own supplies or equipment to perform their jobs.
All payments for the nurses’ services were made directly to the company. The nurses had no contact with insurance companies or any other third-party reimbursement providers. The company set the nurses’ work schedules. Most nurses were assured full-time work. If a nurse could not work her assigned shift, she could not arrange for her own replacement. The third-party physicians for each of the company’s clients prescribed the patient’s plan of care. The company was ultimately responsible for ensuring the nurses followed those plans. The company had case managers on hand who solicited feedback from clients. The company directed any type of counseling, discipline, reassignment or termination. Based on all these factors, it was easy for the court to conclude the nurses were employees rather than independent contractors.
B. Denial of Section 530 Relief. Section 530 is a get out of jail free card that provides an employer is automatically exempt from employment tax liabilities for worker misclassifications if all of the following requirements are met:
- The employer never treated the worker as an employee for any period (the “historic treatment” requirement);
- The employer does not treat workers in similar positions as employees (the “substantive consistency” requirement);
- All Federal tax returns (i.e., Forms 1099s) were filed for the worker as an independent contractor (the “reporting test”); and
- The employer had a reasonable basis for not treating the worker as an employee (based on past court cases, revenue rulings, a long-standing industry practice, prior IRS audit, or a strong opinion letter from a tax professional) (the “reasonable basis” test).
The court quickly ruled Section 530 relief was not available. The company treated the same nurses as employees in one period and as independent contractors in another. The company, therefore, did not meet the historical treatment requirement. Also, similarly situated workers were sometimes treated as independent contractors and other times as employees. Thus, the company also failed the substantive consistency requirement.
C. Penalties. The court upheld penalty assessments since the company failed to present any evidence there was reasonable cause for its noncompliance. Although the company’s president and sole shareholder claimed she was simply following the advice of her CPA, she failed to offer any evidence supporting those claims.
IV. Wife Entitled to Innocent Spouse Relief Even Though She Was Still Living with Her Ex-Husband; Pocock, TC Memo 2022-55.
Mr. and Mrs. Pocock had a tumultuous relationship, including allegations of verbal and physical abuse by Mr. Pocock. From 1995 through 2005, Mr. and Mrs. Pocock filed joint tax returns that contained large tax refunds due to Mr. Pocock overstating his federal tax withholdings. In some cases, Mr. Pocock signed Mrs. Pocock’s name to endorse the refund checks. Mrs. Pocock filed an innocent spouse relief request, which was denied by the IRS. She appealed to the Tax Court.
Although Mrs. Pocock divorced Mr. Pocock, she was still living with him because she needed to save expenses. Mrs. Pocock believed her living arrangement with Mr. Pocock was more reliable than a typical rental situation. Judge Vasquez applied Revenue Procedures 2013-34 and 2013-43 to determine whether Mrs. Pocock qualified for equitable relief under Section 6015(f). The court held in favor of Ms. Pocock, noting:
(1) no assets were ever transferred by Mr. Pocock to Mrs. Pocock as part of any fraudulent scheme;
(2) Mrs. Pocock did not knowingly participate in the filing of any fraudulent returns; and
(3) all of the tax shortcomings were solely attributable to the income tax withholding misstatements by Mr. Pocock.
The court concluded Mrs. Pocock would suffer economic hardship if she was not granted equitable relief. The court found although Mrs. Pocock did not have actual knowledge of Mr. Pocock’s fraudulent activities, she likely had constructed knowledge of the fraud and had reason to know of her husband’s withholdings overstatements. However, there was credible testimony as to physical and verbal abusive behavior by Mr. Pocock. Because of that abuse, the court held Mrs. Pocock’s constructive knowledge did not prevent equitable relief. Also, Mrs. Pocock credibly testified her economic situation necessitated she have a roommate. That Mrs. Pocock was still living with Mr. Pocock when she applied for innocent spouse relief did not contradict her allegations of earlier abuse when the joint returns were filed.
V. No Innocent Spouse Relief Even Though the Husband Signed the Wife’s Name to Tax Return; Jones vs. Commissioner, 129 AFTR 2d 2022-588 (9th Cir. 2022).
In Jones, Mrs. Jones argued she was entitled to innocent spouse relief because she did not consent to her ex-husband’s signing her name to a joint tax return for 2010. The court, however, refused to grant relief finding Mrs. Jones tacitly consented to her husband’s signing the return on her behalf. The court found the following factors determinative:
- Jones provided her ex-spouse with a copy of her Form W-2 and other tax information presumably so Mr. Jones could use it to file their 2010 joint tax return;
- Jones failed to file a separate tax return for 2010 even though she otherwise would have been required to file a separate return; and
- In later years, Mrs. Jones allowed her new husband to sign tax returns on her behalf.
Once the court determined Mrs. Jones had reason to know her ex-husband would not pay the tax liability reported on the 2010 return, it was easy to conclude that she did not qualify because she had tacitly consented to her husband’s signing the joint return for her.
VI. Fraudulent Conveyance, Alter Ego, and Nominee Theories for Real Estate Liens; TBS Properties, LLC vs. United States 129 AFTR 2d 2022-1080.
In TBS Properties, various members of the Perry family owned a number of restaurant franchises. There were thirteen restaurants, each of which was operated by a separate corporation. The Perry family also owned the real property on which each restaurant was located. The real estate was owned by thirteen separate LLCs. In 1998, Mr. and Mrs. Perry transferred real property to one of the LLCs, called TBS Properties, LLC. Beginning in 2000, TBS leased its real property to RAEDON, Inc., via an unsigned lease arrangement. In 2012, when Mr. and Mrs. Perry died, all of their closely-held business interests passed to trusts for the benefit of their heirs. Between 2015 and 2017, RAEDON amassed over $150,000 in back taxes. In 2019, the IRS filed a notice of Federal tax lien against the property held by TBS that was being leased to RAEDON. TBS then brought a quiet title action against the IRS requesting a judicial determination and order that “the United States has no lien interest or any other interest in or against” the TBS property.
The IRS sought a declaratory judgment confirming its lien was valid based on three successor liability theories: (1) the fraudulent transfer theory; (2) the alter ego theory; and (3) the nominee theory. TBS then moved for summary judgment on all three theories.
On the fraudulent transfer argument, the District Court granted summary judgment in favor of TBS because RAEDON never transferred any real property to TBS. Instead, the transfer came directly from Mr. and Mrs. Perry. As to the alter ego claims, the court noted the IRS and the taxpayer agreed for the IRS to be successful, regardless of whether the court applied federal law or state law, the IRS would have to prove two elements to establish alter ego liability: (1) unity of control and (2) observance of the corporate form would sanction fraud or promote injustice. The court noted unity of control was clearly at play because the corporations and the owners of the properties (the LLCs) had common ownership, officers, and directors. That, combined with the absence of an executed written lease between TBS and RAEDON, could lead the trier of fact to conclude unity of control existed. The court held a trier of fact likewise could determine there was fraud because RAEDON’s tax liabilities had gone unpaid when there were various cash transfers between RAEDON and TBS. Finally, the court held the IRS could pursue the nominee liability theory. Since the theory had never been expressly rejected by Arizona courts, the court could not grant summary judgment in favor of TBS on that theory.
VII. Penalty for Failing to Report Form 1099 Income; Larochelle vs Commissioner, TC Summary Opinion 2022-12.
During 2017, Mr. Larochelle was engaged in more than ten partnerships that required filing income tax returns in more than five states. In 2017, Mr. Larochelle received an IRA distribution of $238,000 that was not reported on his personal tax return. The IRS assessed a 20% substantial understatement penalty, under Section 6662(a) and (b)(2), equal to 20% of the underpayment attributable to the substantial understatement of tax. An understatement is substantial if it exceeds the greater of $5,000 or 10% of the tax required to be shown on the return. Section 6662(b)(1)(A).
Section 6662 penalties can be avoided if the taxpayer shows it acted with reasonable cause and in good faith. Section 6664(c)(1). Mr. Larochelle did not dispute he received a Form 1099-R reporting the IRA distribution. He argued, however, he should not be subject to a penalty because he did not remember having received the Form 1099R. The courts have held the nonreceipt of tax information, such as a Form W-2 or Form 1099, does not excuse the taxpayer from his or her duty to report that income. DuPoux vs. Commissioner, TC Memo 1994-448 and Ashmore vs. Commissioner, TC Memo 2016-36. Mr. Larochelle also argued he had reasonable reliance on the advice of a tax return preparer that should constitute reasonable cause for omission of the $238,000 IRA distribution on his return. Mr. Larochelle claimed he gave everything he had to his tax return preparer. However, reliance on the advice of a tax return preparer does not constitute reasonable cause if the taxpayer did not provide the preparer with all information necessary to prepare an accurate return. Enoch vs. Commissioner, 57 TC 781 (1972). Accordingly, the court upheld the penalty.
VIII. CPA Denied NOL Carryforwards and Hit with Negligence Penalties; Amos vs. Commissioner, TC Memo 2022-109.
Amos was a certified public accountant who owned multiple restaurant franchise businesses. Amos claimed NOL carryforward deductions on her 2014 and 2015 tax returns. The Tax Court disallowed such deductions because Amos was unable to establish the original amount of the NOLs and the NOL carryovers allowable in years leading up to 2014 and 2015. To claim an NOL deduction, the taxpayer must (1) establish and verify the NOL deduction that occurred in the earlier year and (2) verify the taxpayer’s taxable income for all subsequent years to confirm the NOL had not been previously utilized in full.
The court upheld the 20% accuracy related penalty under Section 6662(a) and (b)(1) because Amos had no reasonable cause for her tax understatements. Amos claimed she relied on her CPA for advice. However, Amos was able to establish only that her CPA gave her advice as to the underlying loss year return rather than the 2014 and 2015 years at issue. Moreover, because Amos was an experienced CPA, she could not rely on past years’ practices nor could she reasonably assert she did not know each year stands on its own.
Keith A. Wood is an attorney with Carruthers & Roth, P.A. in Greensboro.