Category Archives: Tax Attorney

Guilty until Proven Innocent? Tax Court Burden of Proof

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Philip Falco
Guilty until Proven Innocent? Tax Court Burden of Proof

Who has the upper hand in Tax Court, the IRS or the Taxpayer? You decide.

You are considering filing a petition with the United States Tax Court perhaps regarding your Notice of Deficiency post IRS audit. Here are a few rules of play to be aware of.

The IRS’s determinations in a notice of deficiency are generally presumed correct, and taxpayers bear the burden of proving them erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). This puts the main hurdle on the Taxpayer. To put it in common terms, the Taxpayer is presumed guilty, not innocent (these are civil matters, not criminal so this is an analogy). Walking into Tax Court, Taxpayer must prove the IRS’s position is wrong.

All is not hopeless. However, if a taxpayer produces credible evidence with respect to one or more factual issues relevant to the taxpayer’s tax liability, the burden of proof may shift to the IRS as to that issue or issues. § 7491(a)(1). Likewise, the IRS’s determination does not receive a presumption of correctness if the determination is shown to be arbitrary and capricious. Helvering v. Taylor, 293 U.S. 507, 514 (1935); 9 [*9] Cohen v. Commissioner, 266 F.2d 5, 11 (9th Cir. 1959), remanding T.C. Memo. 1957-172. Also, the IRS bears the burden of proving new matters asserted in its answer. See Rule 142(a).

Tax Court proceedings are conducted in accordance with the Federal Rules of Evidence. § 7453; Rule 143(a).

Section 7491(a)(1) provides that if, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the IRS shall have the burden of proof with respect to that issue. See Higbee v. Commissioner, 116 T.C. 438, 440–41 (2001). For the burden to be placed on the IRS under this section, however, the taxpayer must demonstrate that he has: (1) complied with the requirements under the Code to substantiate any item, (2) maintained all records required under the Code, and (3) cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews. See § 7491(a)(2); Higbee, 116 T.C. at 440–41.

IRS Pre-Audit Investigations

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Philip Falco

Audit “Flags” – Straight from the Internal Revenue Manual

Large Unusual Questionable Items (LUQs)

The definition of a large, unusual, or questionable item will depend on the examiner’s perception of the return as a whole and the separate items that comprise the return. Some factors to be considered when identifying LUQs are:

  1. Comparative size of the item — an expense item of $6,000.00 with total expenses of $30,000.00 would be a large item; however, if total expenses are $300,000.00, the item would not be generally considered a large item.
  2. Absolute size of the item — despite the comparability factor, size by itself may be significant. For example, a $50,000 item may be significant even though it represents a small percentage of taxable income.
  3. Inherent character of the item — although the amount of an item may be insignificant, the nature of the item may be significant; e.g., airplane expenses claimed on a plumber’s Schedule C.
  4. Evidence of intent to mislead — this may include missing schedules, incomplete schedules, misclassified entries, or obviously incorrect items on the return.
  5. Beneficial effect of the manner in which an item is reported — expenses claimed on a business schedule rather than claimed as an itemized deduction.
  6. Relationship to other items — incomplete transactions identified on the tax return. For example, the taxpayer reported sales of stock but no dividend income.
  7. Whipsaw issues — occur when there is a transaction between two parties and characteristics of the transaction will benefit one party and harm the other. Examples include alimony vs. child support, sale vs. rental/royalty, employee vs. independent contractor, gift vs. income.
  8. Missing items — consideration should be given to items which are not shown on the return but would normally appear on the returns of similar taxpayers. This applies not only to the examination of income, but also to expenses, deductions, etc., that would result in tax changes favorable to the taxpayer.

The foregoing is an excerpt from the Internal Revenue Manual.  These are some of the recommended procedures to IRS Agents when doing background work before a taxpayer is contacted.

The tax return would have been flagged already.  It is now in the hands of the scrutinizing IRS Agent.  These are some of the items the agent will look at closely before contacting the taxpayer.

Click here to read about IRS Audits including IRS letters.

Excerpt from Publication 1, Taxpayer Rights

The process of selecting a return for examination usually begins in one of two ways. First, we use computer programs to identify returns that may have incorrect amounts. These programs may be based on information returns, such as Forms 1099 and W-2, on studies of past examinations, or on certain issues identified by compliance projects. Second, we use information from outside sources that indicates that a return may have incorrect amounts. These sources may include newspapers, public records, and individuals. If we determine that the information is accurate and reliable, we may use it to select a return for examination.

Judge Learned Hand on Taxes

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Philip Falco

By Philip Falco, Attorney, CPA. In an opinion penned in 1934, Judge Learned Hand endorsed the use of tax planning.  In Helvering v. Gregory, 69 F.2d 809, Judge Learned Hand wrote:

“Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

To put it another way, there is no patriotic duty to pay more tax than the least tax payable under the tax code. This is the essence of tax planning in a nutshell.

A solid understanding of the tax code is what it takes to navigate to the least tax payable under the tax law.

Offshore Voluntary Disclosure Initiative (OVDI) (OVDP) Program

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Philip Falco

The clock is ticking on this tax amnesty program provided by the IRS.

Countries from around the world have disclosed or are in the process of disclosing United States account holder information.  If a taxpayer is caught before entering OVDI / OVDP the penalties are draconian.  Penalties likely include criminal prosecution.

If the taxpayer has offshore accounts or properties, it is critical that the taxpayer speak with a tax attorney and not an accountant.  The accountant privilege does not apply to criminal proceedings.  However, the attorney-client privilege does apply to criminal proceedings.  The accountant could be subpoenaed to testify against the taxpayer at the criminal trial.

Philip Falco, CPA, Juris Doctor – Honors will work on your case to gain acceptance in OVDI / OVDP.

Quiet disclosures are not the answer.  This is where a taxpayer begins to file proper schedules on his or her tax return without entering OVDI / OVDP.  The IRS has specifically reserved the right to pursue criminal prosecution in these cases.

Because of the vast disclosures from foreign countries, participation in OVDI / OVDP is becoming more difficult every day.

The disclosures required for  OVDI / OVDP are massive and must be done precisely.  The worst fear would be accusation of a half-truth facing criminal prosecution.

We can prepare the required amendments to your returns and prepare the complete package to the IRS as required by OVDI / OVDP.

In the opinion of Philip Falco, CPA, Juris Doctor, the offshore initiative is the most significant tax development since the 1986 revisions to the internal revenue code that cracked down on tax shelters (revisions to passive activities and at-risk tax rules).

See our page on OVDP / OVDI