Taxpayer Not Entitled to Itemized Deductions on Substitute Return Filed by IRS

(Parker Tax Publishing October 2019)

The Tax Court held that a taxpayer who failed to file a tax return because he was incarcerated could not itemize deductions for the year at issue because, under Code Sec. 63, a taxpayer must make an election in order to itemize and by failing to file a return, the taxpayer failed to make the election. According to the court, the taxpayer's argument that (1) he did not have access to certain records due to his incarceration, and (2) if he had filed a return, he could have reported deductible expenses in excess of the standard deduction, did not create a genuine dispute as to a material fact sufficient to overcome the IRS's motion for summary judgment. George v. Comm'r, T.C. Memo. 2019-128.

Background

Claude Tate George is a former professional basketball player who, in 2013, was convicted of wire fraud for running a real estate Ponzi scheme. George was incarcerated for all of 2013. In 2013, George received a National Basketball Association (NBA) pension distribution of $208,111 through U.S. Bank, N.A. The bank withheld $41,622 of income tax from the distribution. George was 45 years old on December 31, 2013.

George never filed a tax return for 2013. As a result, the IRS made a substitute return for him. In May 2015, IRS Revenue Agent Dennis Landadio executed a Code Sec. 6020(b) certification of a substitute return for George for his 2013 tax year, showing an unpaid tax balance of $28,696. To arrive at that balance, Landadio included in George's 2013 gross income the $208,111 pension distribution. Then, assuming that George's 2013 filing status was single, he allowed George the applicable standard deduction for 2013 of $6,100 and a personal exemption of $3,900, resulting in taxable income of $198,111. Landadio calculated an income tax of $49,507 and also a Code Sec. 72(t) early distribution penalty tax of $20,811, since George had not yet reached age 59 1/2 and thus was subject to the penalty resulting from an early pension plan distribution. Landadio summed those two amounts to arrive at a deficiency of $70,318. He then subtracted the $41,622 of withholding, which resulted in the unpaid tax balance of $28,696 (plus the additions to tax for failure to timely file a return and pay the tax). In July of 2015, the IRS mailed to George at his last known address a statutory notice of deficiency reflecting the above.

George challenged the notice of deficiency in the Tax Court. He argued that (1) his incarceration prevented him from filing a tax return, (2) all taxes owed on the distribution were withheld by the NBA Pension Office, and (3) paying the amounts owed under the notice would pose a hardship on him and his family. George contended that his incarceration prevented him from accessing the documentation needed to substantiate his deductible expenses and, therefore, a genuine dispute of material fact existed as to his deductible expenses.

Analysis

The Tax Court granted summary judgment for the IRS after finding that the IRS properly determined a deficiency of $70,318 in George's 2013 tax liability. The court found that George could not itemize deductions for 2013 because he did not file a return. The court explained that, under Code Sec. 63(e)(1), no itemized deductions are allowed unless the taxpayer makes an election, and Code Sec. 63(e)(2) provides that such an election must be made on the taxpayer's return. Thus, if a taxpayer fails to file a return, he or she has made no election to itemize deductions. The court further found that if an individual does not file a return and, as a result, the IRS prepares a substitute return, then the individual has made no election and may not claim itemized deductions.

The court noted that George made no argument that the full amount of his pension distribution should not be included in his 2013 gross income. His only argument contesting the deficiency was that, if he had not been incarcerated in 2013, he might have reported deductible expenses in excess of the standard deduction. The court found that because George did not file a return for 2013, he could not elect to itemize his deduction, so any dispute as to hypothetical expenditures in 2013 would not be a dispute as to a material fact. Therefore, the court concluded that the IRS properly calculated George's income tax and applied the 10 percent penalty for an early pension distribution.

In upholding the penalties, the court found that, even if there was evidence of deductible amounts that were not included on the substitute return, that would not necessarily establish reasonable cause and a lack of willful neglect for not filing the return or paying the tax due. The court explained that the mere fact of George's incarceration in 2013 was not reasonable cause for failing to file a return. The court observed that George never applied for an extension of time to file his return. While George asserted that his incarceration prevented him from gathering documents, the court noted that he never described any expenditures that would qualify for a 2013 deduction or credit. Moreover, while George argued that paying the amounts owed would bring an undue hardship on his family, the court said that George failed to explain why family members did not assist him in gathering documents not in his immediate possession.

For a discussion of itemized deductions available to individuals, see Parker Tax ¶82,125. For a discussion of delinquency penalties, see Parker Tax ¶262,105.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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