Tax Court in Brief | Salter v. Commissioner | Substitute for Return and Itemized Deductions

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Tax Court in Brief | Salter v. Commissioner | Substitute for Return and Itemized Deductions

The Tax Court in Brief – April 4th- April 8th, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

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Tax Litigation:  The Week of April 4th, 2022, through April 8th, 2022

Salter v. Comm’r, T.C. Memo. 2022-9 |April 5, 2022 |Lauber, J. | Dkt. No. 10776-20

Short Summary: Shawn Salter was a district loss prevention manager for Home Depot. He worked from home but traveled regularly by car to the various stores. Home Depot offered reimbursement for travel expenses. Due to being laid off in mid-2013, Salter requested and received a distribution of $37,647 from his retirement plan. He had not reached the age of 59½ years at the time. He failed to file a tax return for 2013, so the IRS prepared a substitute for return on the basis of third-party reporting. The computed tax amount was offset by the standard deduction and tax withheld by Salter’s payors, which resulted in a deficiency liability of $6,109. The issues presented to the Tax Court regarded Salter’s entitlement to itemized deductions with respect to the substitute for return, computation of additional tax for the early distribution from retirement plan, and the addition to tax for failure to file.

Primary Holdings: 

  • Salter failed to file a return and thus made no election for itemized deductions. Therefore, pursuant to 26 U.S.C. § 63(e)(1), he is not entitled to itemized deductions requested with respect to the substitute for return, although he remains entitled to the standard deduction as calculated on the notice of deficiency. Salter failed to prove his entitlement to an alternative tax for the early distribution, and he failed to show that his failure to file was due to reasonable cause and not willful neglect.

Key Points of Law:

  • Burdens of Proof. Generally, the IRS’s determinations are presumed correct, and the taxpayer bears the burden of proving the Commissioner’s determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Taxpayers bear the burden of proving (and substantiating with adequate records) their entitlement to any deductions claimed. Rule 142(a); INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84 (1992); 26 U.S.C. § 6001; Hradesky v. Comm’r, 65 T.C. 87, 89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Treas. Reg. § 1.6001-1(a). A taxpayer is required to maintain records sufficient to enable the IRS to determine the correct tax liability. See Reg. § 1.6001-1(a).
  • Itemized Deductions Based on Substitute for Return. Section 162(a) allows the deduction of “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” The term “trade or business” includes performing services as an employee.
  • Section 63(e)(1) provides that, “[u]nless an individual makes an election under this subsection for the taxable year, no itemized deduction shall be allowed for the taxable year.” Section 63(e)(2) provides that “[a]ny election under this subsection shall be made on the taxpayer’s return.” The statutory direction that an election to itemize deductions “shall be made on the taxpayer’s return” is mandatory. See Jahn v. Comm’r, 392 F. App’x 949, 950 (3d Cir. 2010) (quoting § 63(e)(2)), aff’g per curiamC. Memo. 2008-141. “Thus, if an individual fails to file a return, he has made no election to itemize his deductions.” George v. Comm’r, T.C. Memo. 2019-128, 118 T.C.M. (CCH) 294, 296, aff’d per curiam, 821 F. App’x 76 (3d Cir. 2020).
  • If no return is filed and the IRS prepares a substitute return, then the taxpayer has made no election and may not claim itemized deductions. George v. Comm’r, T.C. Memo. 2019-128, 118 T.C.M. (CCH) 294, 296, aff’d per curiam, 821 F. App’x 76 (3d Cir. 2020); see Zaklama v. Comm’r, T.C. Memo. 2012-346, 104 T.C.M. (CCH) 760, 777.
  • Additional Tax—Early Distribution. If a taxpayer is younger than 59 ½ years at the time of an “early distribution” from a retirement account, a tax equal to 10% of the distribution is assessed. See 26 U.S.C. § 72(t)(1), (2)(A)(i). The additional tax does not apply “to the extent such distributions do not exceed the amount allowable as a deduction under section 213” for medical expenses. at § 72(t)(2)(B). This exception is available only for medical expenses “allowable as a deduction under section 213.” During 2013, medical expenses were deductible under section 213 only to the extent they exceeded 10% of the taxpayer’s adjusted gross income. See 26 U.S.C. § 213(a).
  • Additional Tax—Failure to File. Section 6651(a)(1) provides for an addition to tax of 5% of the tax required to be shown on the return for each month or fraction thereof for which there is a failure to file the return, not to exceed 25% in total. The IRS bears the burden of production on this determination. See 26 U.S.C. § 7491(c). The addition to tax for failure to file does not apply if “it is shown that such failure is due to reasonable cause and not due to willful neglect.” at § 6651(a)(1). The taxpayer bears the burden of proof on this point. Higbee v. Comm’r, 116 T.C. 438, 447 (2001).

Insights: Tax deductions are a matter of legislative grace. To deduct employee business expenses, the taxpayer must have and maintain adequate records, contemporaneously made with the expense, to justify the available deduction. More fundamentally, the taxpayer—pursuant to Section 63(e)(1)— must file a return and make an election for itemized deductions; otherwise, no itemized deductions will be permitted in relation to a substitute for return. Unless a taxpayer can prove that the failure to file a return is due to reasonable cause and due to willful neglect, an additional tax may be assessed, and the IRS’s burden of production to sustain that assessment is not onerous.