Tax Court in Brief | Fields v. Comm’r | IRS Automated Underreporter Program, Gifts from Employer, Accuracy-Related Penalty

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The Tax Court in Brief – November 7th – November 11th, 2022

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Tax Litigation:  The Week of November 7th, 2022, through November 11th, 2022

Fields v. Comm’r, T.C. Summary Opinion 2022-22 | November 10, 2022 | Panuthos, Special Trial J. | Dkt. No. 2925-20S (IRS Automated Underreporter, gifts from employer, unreported gross income, and accuracy-related penalty)

Summary: Pursuant to 26 U.S.C. § 7463(b), this decision is not reviewable by any other court, and the opinion shall not be treated as precedent for any other case. The case regards a deficiency determination and a 26 U.S.C. § 6662(a) accuracy-related penalty assessed against petitioners, Jennifer Fields (“Jennifer”) and Walter Fields (with Jennifer, the “Fields”). Jennifer worked for Paragon Canada ULC. Paragon Canada ULC operated in Canada, and it operated in the U.S. as Paragon Gaming (collectively, Paragon). She had a personal relationship with the CEO of Paragon, Scott Menke. On a few occasions, Paragon wired funds to or for Jennifer’s personal benefit, such as for use as a down payment to purchase a residence or other unspecified. In January 2017, she separated from Paragon. In a severance agreement, the respective parties agreed to a write-off of certain employee advances totaling $79,581.50. A revised draft severance agreement modified the consideration but was never signed. Jennifer executed a Form W–9, Request for Taxpayer Identification Number and Certification, which was provided to Paragon. Paragon issued to Jennifer and filed with the IRS a Form 1099–MISC, reporting $79,581 in other income for the year in issue. With help from a tax preparer, the Fields timely filed Form 1040 for the year in issue, but the return did not include any amounts reported on the Form 1099–MISC. The IRS Automated Underreporter (AUR) Program determined a mismatch. The IRS issued a notice of deficiency, adjusting the Fields’ income to include $79,581 in other income from Paragon. The IRS also determined that the Fields were liable for a section 6662(a) and (b)(2) accuracy-related penalty for an underpayment attributable to a substantial understatement of income tax.

Key Issues: (1) Whether the Fields failed to report income of $79,581 for the year in issue? (2) Whether the Fields are liable for a section 6662(a) accuracy-related penalty?

Primary Holdings: Yes and yes. Jennifer did not prove that the amounts received from Paragon, as reflected on the Form 1099-MISC, were intended as gifts. The underreported amount was substantial and the Fields did not show reasonable cause for the underreporting.

Key Points of Law:

Burdens of Proof. Generally, the IRS’s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In order for the presumption of correctness to attach to the deficiency determination in unreported income cases in the U.S. Court of Appeals for the Ninth Circuit, the IRS must establish “some evidentiary foundation” connecting the taxpayer with the income-producing activity or demonstrate that the taxpayer received unreported income. Weimerskirch v. Commissioner, 596 F.2d 358, 361–62 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). Once that occurs, the burden shifts to the taxpayer to show by a preponderance of the evidence that the determination was arbitrary or erroneous. Klootwyk v. Commissioner, T.C. Memo. 2006-130, slip op. at 4–5.

Unreported Income. Gross income includes “all income from whatever source derived.” See § 61(a). Payments that are “undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion” are taxable as income unless an exclusion applies. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). Section 102(a) excludes from gross income the value of property acquired by gift from gross income.

Gifts from Employer to Employee. Generally, amounts transferred by or for an employer to, or for the benefit of, an employee are includible in gross income. 26 U.S.C. § 102(c)(1). A gift must proceed from a detached and disinterested generosity, motivated by affection, respect, admiration, charity, or the like. See Commissioner v. Duberstein, 363 U.S. 278, 285 (1960). There is a strong presumption that payments made beyond an employee’s salary are compensation for services and not gifts. See Van Dusen v. Commissioner, 166 F.2d 647 (9th Cir. 1948), aff’g 8 T.C. 388 (1947). A payment between an employer and an employee may be a gift when the relationship between the employer and the employee is personal and unrelated to work. Caglia v. Commissioner, T.C. Memo. 1989-143; Harrington v. Commissioner, T.C. Memo. 1958-194.

Section 6662(a) Accuracy-Related Penalty. Section 6662(a) and (b)(2) imposes an accuracy-related penalty of 20% on any portion of an underpayment of tax required to be shown on a return attributable to the taxpayer’s “substantial understatement of income tax.” An understatement of income tax is substantial if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return or $5,000. 26 U.S.C. § 6662(d)(1)(A).

Burden of Proof for Penalty. The IRS generally bears the burden of production with respect to a section 6662 penalty. See 26 U.S.C. § 7491(c). To satisfy that burden the IRS must offer sufficient evidence to indicate that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once that burden is met, the taxpayer must come forward with evidence sufficient to show the Court that the determination is incorrect. Id. at 446–47. An understatement may be deemed “substantial” where it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. See 26 U.S.C. § 6662(d)(1)(A).

IRS Automated Underreporter (AUR) Program. The IRS’s AUR program matches third-party-reported payment information against a taxpayer’s already-filed tax return. Essner v. Commissioner, T.C. Memo. 2020-23, at *11. When there is a discrepancy, the AUR program calculates a proposed deficiency based on the statutory scheme and prepares a letter to the taxpayer requesting an explanation for the discrepancy. Service Center Notice 200211040 (Mar. 15, 2002). If the taxpayer does not respond, the program will issue a notice of deficiency. Id. If the taxpayer does not respond to the notice of deficiency, the deficiency will be assessed. Id. Accuracy-related penalties determined by an IRS computer program without human review are “automatically calculated through electronic means” and are thus exempt from the written supervisory approval requirement that generally applies to such penalties. See Walquist v. Commissioner, 152 T.C. 61, 73 (2019). This exception includes returns processed through the AUR program when the IRS issues a CP2000 notice to a taxpayer and the taxpayer fails to respond to the notice. See Walton v. Commissioner, T.C. Memo. 2021-40, at *9–10; Ball v. Commissioner, T.C. Memo. 2020-152, at *12– 13.

Reasonable Cause and Good Faith. Once the IRS Commissioner has met its burden, the taxpayer may avoid a section 6662(a) accuracy-related penalty to the extent that he or she can demonstrate (1) reasonable cause for the underpayment and (2) that he or she acted in good faith with respect to the underpayment. 26 U.S.C. § 6664(c)(1). The decision as to whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, considering all pertinent facts and circumstances, including: (1) the taxpayer’s efforts to assess the proper tax liability, (2) the knowledge and experience of the taxpayer, and (3) reliance on the advice of a tax professional. Treas. Reg. § 1.6664-4(b)(1). An honest misunderstanding of the law that is reasonable in the light of the facts and circumstances may support a conclusion that a taxpayer acted with reasonable cause and in good faith with respect to a reported position. Id.; see also Higbee, 116 T.C. at 448–49. Generally, the most important factor is the extent of the taxpayer’s efforts to assess his or her proper tax liability. Treas. Reg. § 1.6664-4(b)(1). Statutory complexity alone does not constitute reasonable cause. Barnes v. Commissioner, T.C. Memo. 2012-80, aff’d, 712 F.3d 581 (D.C. Cir. 2013).

Insights: Taxpayers bear the burden of proof that amounts received from an employer were intended as gifts that should not be taxed under section 102. Technology utilized by the IRS, such as via the AUR program, can serve as an efficient and effective way for the IRS to identify discrepancies in taxpayer reporting and actual tax liability. When there is a discrepancy between third-party reporting and taxpayer reporting, the AUR program calculates a proposed deficiency based on the statutory scheme and prepares a letter to the taxpayer requesting an explanation for the discrepancy. Upon receipt, the taxpayer is wise to engage professional counsel to address the matter. Failing to respond will likely result in a deficiency determination, which then could result in accuracy-related penalties.