I agree with the IRS’ and Tax Court’s interpretation of the law, but Mr. Udeobong sure paid through the nose – twice, to be exact. I’ll save you the gory details. In fact, they might make you a little less sympathetic. In any case, Mr. Udeobong still took a lickin’. Here is the summary and sanitized version of the recent Tax Court Memo decision.
Mr. Udeobong had a medical supply and equipment business that reported its taxable income on the cash basis of accounting. Sometime before 2005, Mr. Udeobong reported as income receipts from Cigna in the amount of about $260,000.
Mr. Udeobong had a dispute with Cigna. Sometime between 2005 and 2010, Mr. Udeobong repaid the $260,000 to Cigna and did not deduct the repayments.
In 2010, Cigna repaid the $260,000 to Mr. Udeobong. Since he had already taken into income the payments and had not deducted them when he returned the money, Mr. Udeobong thought he had taken care of his tax liability.
In 2012, the IRS issued a deficiency notice to Mr. Udeobong based on the omission of about $152,000 of the $260,000 that he received in 2010 and did not report as income. Of course, Mr. Udeobong had already paid taxes on this income once before. That does not matter. In general, a cash basis taxpayer reports receipts as income.
The statute of limitations had already run for the year he first reported the income and for the year in which he may have taken, but did not take, a deduction for paying the money back. He could not amend his returns for these years. The Tax Court ruled that he had to pay tax on the $152,000 again in the year of receipt – 2010.
So, Mr. Udeobong paid taxes on $152,000 twice. The IRS said he was also was liable for the substantial understatement penalty of 20% of the tax underpayment in 2010.
Mr. Udeobong did have a small victory in this bruising battle. After filing its paperwork with the Tax Court, the IRS caught the difference between the $260,000 received and the $152,000 on which it computed the tax deficiency. It amended its answer to the taxpayer’s Tax Court petition and asked for more money from Mr. Udeobong. The Tax Court replied that it is within the rights of the IRS to ask for more in such a situation and it is within the rights of the Tax Court to reject the request. So, the Tax Court rejected the IRS’ amendment to its answer. I guess the court thought that the law and the IRS had beaten up on Mr. Udeobong enough.
However, the Tax Court upheld the 20% penalty. It said that paying your taxes on the amount in a prior year did not represent “reasonable cause” or “good faith” for not paying the taxes again. Yep, you read that right.
Just a small advertisement here. Mr. Udeobong apparently prepared his own tax returns. He represented himself without legal counsel before the Tax Court. This is one of those times that some professional help would have been well worth the cost.