06 Sep No TurboTax Defense for Bad Tax Deductions
There may be no “TurboTax defense” for taxpayers when they rely on tax preparation software to lure them into claiming bad tax deductions, according to a recent decision of the U.S. Tax Court. In Bulakites v. Comm’r., T.C. Memo 2017-79, the taxpayer was an insurance consultant, serving a clientele of mostly accountants. Rather than enlisting one of those qualified professionals to prepare his income tax returns, the taxpayer turned to a software package (proving the adage “penny wise, pound foolish”). When a deficiency was flagged by the IRS, the Tax Court heard this case dealing with several issues: the perils of paying more alimony than required under a divorce instrument; the need to document one’s business expense deductions; and the requirements for utilizing a net operating loss to offset taxable income.
Prior to his career as an insurance professional, Mr. Bulakites got involved in an entrepreneurial venture that left him with a half-million dollar debt, which he financed by taking a loan against his home. Unfortunately, the Great Recession of 2009 tanked the value of his home just when he needed to sell it to pay the debt, and his wife walked out the door to file a divorce.
In the aftermath, Mr. Bulakites used software to prepare tax returns on which he made several mistakes:
- He had a written agreement to pay $2,000 per month alimony to his wife until the house would sell, but orally amended the agreement to pay $5,000 per month. He declared the $5,000 per month as an alimony deduction, without meeting the legal requirement of having a signed divorce instrument (agreement or order). An oral modification of a written instrument does not meet section 71’s requirements. Sec. 71(b)(2); Gordon v. Commissioner, 70 T.C. 525, 529-30 (1978); Larievy v. Commissioner, T.C. Memo. 2012-247; Ellis v. Commissioner, T.C. Memo. 1990-456; sec. 1.71-1(c), Income Tax Regs.
- The taxpayer deducted the interest he was paying on the loan taken to satisfy the business-related debt. But, he was unable to produce documents proving how much of his loan payments were principal, how much tax-deductible interest, and the nexxus to the business deal. The Tax Court could not determine, in the absence of records, whether the loan had been refinanced, extended or otherwise. The deduction was disallowed.
- The taxpayer claimed a $185,673 net loss carry forward. Section 172 of the Tax Code authorizes a taxpayer to carry a business operating loss into future tax years if the loss is greater than income in the loss year. The excess portion of the loss can be carried forward to offset future income until it is used up, but not longer than 20 years. First, however, the taxpayer must carry back the loss for two years, by amending the prior years’ tax returns if necessary. Here, the taxpayer failed to maintain and produce business records proving the source of the loss and other key facts, so the deduction was disallowed.
Mr. Bulakites testified that the tax preparation software “lured him” into taking the bad tax deductions, but no matter. The Tax Court did not excuse the taxpayer from sec. 6662 accuracy-related penalties. Because his mistakes exceeded the threshold of $5,000 or 10% of the tax due, he was subjected to the enhanced penalty for “substantial” inaccuracy. As the Tax Court wrote: “He tried to blame TurboTax for his mistakes, but ‘[t]ax preparation software is only as good as the information one inputs into it.’ Bunney v. Commissioner, 114 T.C. 259, 267 (2000).” No word whether the software publisher will adopt that as its marketing slogan.