Nardone Law Group’s experienced tax attorneys, in Columbus, Ohio, routinely assist individuals and businesses that become subject to an Internal Revenue Service audit or examination. An IRS audit or examination occurs when the IRS selects a tax return and reviews the taxpayer’s records from which the reported information on the tax return is derived. One of the most important things taxpayers can do to avoid a potential audit or examination is to maintain adequate personal and business records. While many tax practitioners advise clients to maintain tax records for seven years, Nardone Law Group recommends that tax records be retained indefinitely.
When taxpayers are subjected to an audit or examination, properly retained and organized records will help to effectively defend against the possibility of an assessment of additional taxes, as well as accuracy-related penalties. Proper documentation allows taxpayers to substantiate all business or personal expenses deducted on a tax return and will help to resolve any discrepancies that may arise. A recent U.S. Tax Court decision, which upheld an accuracy-related negligence penalty against a military service member, exemplified the IRS’ ability to assess penalties against negligent taxpayers.
Tax Court Upholds IRS Determination Regarding Charitable Deductions
In Thad D. Smith v. Commissioner, the U.S. Tax Court addressed the issue of tax deductions for charitable donations and the IRS’ ability to assess accuracy-related penalties for negligently unsubstantiated deductions. The petitioner, a pro se military service member, timely filed a federal income tax return for 2009, on which he claimed itemized deductions of $52,810. Upon audit, the IRS determined that $35,238 of these deductions should be disallowed due to a lack of substantiation. While the case was being considered by the IRS Appeals Office, the petitioner submitted an amended 2009 return, increasing his claimed deduction for noncash charitable contributions from $490 to $27,767. He based this new amount on clothing and other household items that he allegedly donated to the American Veterans National Service Foundation (AMVETS) in 2009.
IRS determinations in a notice of deficiency are generally presumed correct, so taxpayers bear the burden of proving that determinations are erroneous. Taxpayers must demonstrate their entitlement to deductions and are required to substantiate their claims. For noncash charitable contributions, the substantiation requirements become increasingly more stringent as the gifts increase in value. The most basic requirement provides that an individual may deduct a gift of $250 or more only if he substantiates the deduction with a “contemporaneous written acknowledgement of contribution by the donee organization.” This acknowledgment must include a description of any property other than cash.
The petitioner did not maintain written records establishing when or how the items were acquired, or what their cost bases were. Furthermore, he obtained blank signed forms from AMVETS and later filled them out himself by inserting supposed donation values. The court held that the petitioner failed to satisfy the “contemporaneous written acknowledgement” requirement, and subsequently disallowed any portion of the additional deduction claimed on his amended 2009 return.
Accuracy-Related Negligence Penalty
IRC section 6662 imposes a 20% penalty upon the portion of any underpayment attributable to negligence or the disregard of rules or regulations by a taxpayer. “Negligence” includes any failure to make a reasonable attempt to comply with the tax laws, and “disregard” includes any careless, reckless, or intentional disregard. With respect to an individual taxpayer’s liability for a penalty, the IRS bears the burden of proving that the penalty is appropriate. Once the Commissioner meets this burden of production, the taxpayer must prove that the determination is incorrect.
As a result of the petitioner’s unsubstantiated deductions, the IRS’ notice of deficiency assessed an accuracy-related penalty of $1,881. The petitioner acknowledged at trial that he had no basis for claiming most of the deductions, effectively discharging his burden of production. Therefore, the court upheld the IRS’ imposition of the accuracy-related penalty.
NLG Comment: This case is an excellent example of why taxpayers need to carefully organize and retain their personal and business records. Detailed records and files will help taxpayers defend against the assessment of additional taxes or penalties.
Contact Nardone Law Group
Nardone Law Group represents individuals and businesses in a multitude of federal tax matters, including taxpayers who are subjected to an IRS audit or examination. If you are facing an IRS tax audit or examination, or if you wish to learn more about how to adequately maintain your records, contact one of our experienced tax attorneys today. Nardone Law Group’s tax lawyers and professions have vast experience representing clients undergoing IRS audits and examinations. We will thoroughly review your case to determine what options and alternatives are available.