Part One of the continuing series: Why the IRS does take the money.
A resident of Erie County recently found herself confronted with a small IRS tax issue, which through great overreach by the IRS, blew up into an extremely hostile situation with the agency. Fortunately, her attorney William Winspear managed to win her case and at the same time secure a Court Protective Order against the agency.
The taxpayer owned and operated a closely held one person corporation and received a payment of funds from that corporation, which her return preparer entered on the wrong line of her tax return. For reasons still unknown, the preparer reported some $21,000 in income received from the corporation on line 21 (the other income line) of the taxpayer’s Form 1040, instead of reporting the payment as wages or a dividend. The corresponding Form 1120 had deducted the same $21,000 with a notation “owner withdraw.”
The IRS picked up on this error and sent the taxpayer a Notice of Deficiency alleging that $21,000 was subject to “self-employment” tax and wanted $2,200 of additional tax. In response, her attorney, William Winspear, filed a petition in the U.S. Tax Court, disputing the IRS’ allegation.
During the litigation, her attorney offered to settle the case by classifying the payments wages. That would have saved the taxpayer approximately $1,000 and the IRS would have been entitled to $1,200.
However, the IRS refused to settle the case under the “wages” theory because the corporation, out of business for three years, did not issue a W-2 to the shareholder or file a related Form 941.
The Office of IRS Appeals did offered to settle the case by either “allowing” the taxpayer to concede that the payment was subject to self-employment tax, which there was no way it could have been, or they would accept the wages theory, but the taxpayer would have to “promise” to file any missing corporate tax returns and pay the related corporate FICA tax, with penalties and interest. Her attorney declined that preposterous counteroffer because paying the corporate taxes would have cost the taxpayer more than conceding the case and under no legal theory was the taxpayer liable for the corporate taxes, penalties or interest.
The case was transferred from IRS Appeals to IRS Chief Counsel’s office for trial preparation. Her attorney again offer Chief Counsel the wages theory settlement and that office also countered by offer to allow the taxpayer to concede the case, or the IRS would take the wages settlement but refer the case for further investigation. An investigation that could, at best, get them a $1,200 non-trust fund tax liability against a corporation that had zero assets and had been out of business for three years. The IRS attorney that made this offer also began to use language such as Trust Fund Recovery Penalty, Alter-Ego, Nominee, evasion of payment and “it doesn’t smell right.” None which made any sense because to the taxpayer’s attorney because he had already offered to pay the trust fund – thus no trust fund penalty could be asserted: the taxpayer reported had all the income on her 1040 – thus no evasion of payment could be asserted and there was no evidence, whatsoever, that the corporate veil could or should be pierced: thus no Alter-ego or Nominee could be asserted.
Due to the IRS’ hostile and misguided position, her attorney then told the IRS that (because they simply would not take the money offer – as any other creditor in the world would have done) the wages theory was off the table and at trial we planned to prove that the funds paid to the shareholder were controlled by either I.R.C. § 301 and was a dividend or return of basis, or I.R.C. § 334 and was payment received in exchange of her stock due to the liquidation of the corporation (which went out of business in the year the payment was made). Under any of these theories, the taxpayer would be due a refund because she had already reported the payment and paid tax at ordinary income rates. Distributions under subchapter C, were all taxed at capital gains rates – thus the refund.
In response to this, the IRS insisted that the trial, scheduled for April 13, 2015, be continued for a year so that they could further investigate a three year defunct, no asset, sole shareholder, and sole employee corporation over a $2,200 tax liability, which we had offer $1,200 to settle.
At the pre-trial conference, her attorney objected to the continuance and the continuance was denied for various reasons, but chiefly because a $2,200 case does not (most likely ever would) need to be continued.
The IRS then sent an extremely intrusive letter to the taxpayer’s current employer wanting five years of employee compensation records and the phone numbers of the taxpayer’s supervisors for the last five years.
“I was furious.” Winspear said.
In his opinion, this was a prime example of litigation and IRS abuse.
“Why would the mighty IRS need five years of documents and witnesses for a paltry one year, $2,200 case? It was a massive intrusion into my client’s private life with no point, in my view, except to bully her. I bit my tongue in the face of this letter and told my extremely upset client that the trial was only a few weeks away. My client had not been employed at that company for most of the years the IRS inquired about, thus the letter was mostly meaningless.”
“Two days later, an IRS agent walked into my client’s current employer’s office with a Trial Subpoena demanding certain records. None of the information, either sought by the letter or Subpoena was requesting in Discovery and the IRS had gone behind my back – in bad faith – to attack my client – demanding irrelevant information – in an extraordinarily outrageous way.”
“My client advised me that this malicious act on the part of the IRS put her career and income in jeopardy (all over $1,000). At this point I had to act. I requested an emergency pre-trial conference to request a Protective Order, under Tax Court Rule 103.”
U.S. TAX COURT RULE 103. PROTECTIVE ORDERS
1(a) Authorized Orders: Upon motion by a party or any other affected person, and for good cause shown, the Court may make any order which justice requires to protect a party or other person from annoyance, embarrassment, oppression, or undue burden or expense,
On March 24, 2015, the Court granted the Protective Order and quashed the subpoena. An excerpt of that Order is below:
The amount is dispute barely exceeds $2,000 . . . the case is of no precedential value. The IRS nevertheless served a trial subpoena duces tecum on . . . [the] employer seeking its corporate records related to her even though they bear at most a tangential relationship to the dispute. Her lawyer called the Court on March 31, 2015 with an emergency request for a protective order. The IRS did not articulate a good reason for this subpoena, and [her] lawyer stated that enforcement of the subpoena would materially interfere with his client’s current employment.
To save [her] from annoyance, embarrassment, and undue burden—see Tax Court Rule 103(a) – it is therefore
ORDERED that respondent’s subpoena duces tecum to [her] current employer is quashed.
“It goes without saying that, in my opinion, the IRS greatly embarrassed themselves in front of the Court. Moments after that hearing, the IRS phoned me with an offer to settle the case – accepting my corporate distribution theory. Not only did the taxpayer not owe the proposed $2,200 (the Notice of Deficiency Amount) – the IRS was forced to abate $1,196 of additional dollars of tax – all of which entitled the taxpayer to a refund.”
“This case is just one of many that I have been involved with where the mighty IRS misses the point entirely – It spends a great amount of time and resources in a misguided attempt to assert taxes that are impossible to collect (the defunct corporate non-trust fund taxes in this case). Any other creditor on earth would have taken the wages settlement – which was the best they could have done at trial – and put some money in their pocket. But here, in some twisted way – perhaps to teach me and my client a lesson – instead of simply taking the money – they preferred to show us how powerful they were. In the end, the Court showed them that they were just foolish – foolish and without the money.”
For a free initial consultation regarding your tax issue call William Winspear at:
Buffalo (716) 803-8770
Rochester (585) 301-4025