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Money Management (Distributed by the New Jersey Society of Certified Public Accountants)

Tax Tales To Keep You From Being An April Fool

Don't be fooled this tax season. The New Jersey Society of Certified Public Accountants (NJSCPA) provides these tax tales to help you better understand the tax law and avoid paying more than your fair share of taxes.

Monitor Your Trust Income
An individual who was receiving income from a trust suddenly had the income suspended by a state court when a legal dispute over the trust developed. The Internal Revenue Service (IRS) continued to tax the individual on the income he was supposed to receive. No fool, the taxpayer protested his case and the taxes were revoked. Here's why: Income from a trust may be taxable before it is received if the payments are delayed upon the wish of a beneficiary or a trustee. In this case, the court was the reason for the delay, so taxes could not be imposed.
Jeffrey Michael Steingold, TC Memo, 2000-225

Defend Your Innocence
A man filed a joint tax return with his wife, only to find out later that she had embezzled money from her employer. She was sent to prison and the IRS tried to make her husband pay back taxes. The Tax Court ruled in favor of the husband because the IRS had failed to prove he was aware of the embezzled funds. As an innocent spouse, he was not liable for taxes resulting from his wife's illegal activity.
Michael G. Culver, 116 TC No. 15

Pay Back What You Borrow From Your Pension
One individual took a loan from his pension plan and then unexpectedly retired. When told that he had the option of repaying the loan or having his pension reduced, he chose not to repay the loan. The consequences: A 1099 Form was issued indicating the loan amount as taxable income. Although he claimed the loan was repaid through the reduction in his pension, the Tax Court ruled that the unrepaid loan was actually a current distribution from the plan and that, in addition to reducing his remaining pension, it was also taxable. Had he wanted to avoid the tax, he should have repaid the loan.
William J. Broedel, TC Memo, 2001-135

Avoid Double Penalties
Failing to pay taxes and file proper tax forms can result in tax penalties. However, taxpayers who find themselves in these situations should make sure they are not charged double penalties. For example, the Tax Code imposes a penalty of $50 for failing to file a required Form 1099. Another section of the Code imposes a $100 penalty for intentional failure to file the same form. One IRS Service Center inquired about applying both penalties to a single form. The ruling: Only one penalty can be imposed on a single form.
IRS Legal Memorandum 20012704

Pay Yourself What You Deserve
A savvy business owner managed to turn a $200,000 business into a $12.5 million operation. While building the business, he paid himself a hefty salary, which he was able to deduct. He eventually sold the business and became an employee for the new company.

As an employee, he was paid half of his original salary. In response to this reduction, the IRS questioned his original salary saying he had paid himself too much. It then cut the company's deduction for his pay accordingly. The prior owner fought back, saying he had paid himself fairly for the level of work he had performed.

The Tax Court agreed, recognizing that the salary differences reflected his additional responsibilities as the head of the company versus as an employee. The Court found that the above-average rate-of-return the business earned while he was the owner further justified the salary. Thus, the individual was entitled to the larger salary he received as owner, and the original business deduction for that salary was allowed.
Damron Auto Parts Inc., TC Memo, 2001-19

The NJSCPA points out that as long as you believed you followed the law, it's wise to defend your tax position to the IRS. As several of these tax tales indicate, you may win your case and avoid unnecessary taxes.

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Money Management is a weekly column on personal finance distributed by the NJSCPA.

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