Cash for Keys - is it part of the transaction?

[BulldogTom]

Client received a cash payment for not fighting a foreclosure on his personal residence.  Bank issued a 1099MISC.  Client never gave me the 1099.  IRS now wants tax and SE tax for the 1099.

Question - is there any way this payment can be part of the sale or other disposition of the property?  Because if it can, the transaction results in a non-deductible loss on the sale or other disposition of the home. 

Anyone think I am crazy?

Tom
Newark, CA

[DANRVAN]

Client received a cash payment for not fighting a foreclosure on his personal residence.

Was there a contract or an agreement to that effect?  Sounds to me like it would be outside of the property transaction and most likely would go on line 21: defiinetly  no SE tax.

[Catherine]

Sounds to me like you could make a case for adjustment to basis, therefore part of the property sale back to the bank.  After all, there would have been NO payment aside from the imminent foreclosure action.

Edited August 11, 2015 by Catherine

[BulldogTom]

Here is the argument I am planning to take to tax court.  §1001( b ) says the amount realized on the sale or other disposition of an asset is the amount of money received plus the fair market value of property received.  The foreclosure of a home is a sale or other disposition of an asset.  The taxpayer received (realized) money and debt forgiveness.

I can't find a TR or Code section that trumps this one.  I am looking, but all I see is the IRS VITA tax guide saying that if a taxpayer received a 1099MISC it is taxable. 

My argument is §1001 (a) and ( b ) control.

I know the IRS is not going to agree.

Where is Jainen with his encyclopedic knowledge of the IRC when you need him.

Tom
Newark, CA

[kcjenkins]

Sure sounds like a part of the sale transaction to me.  Clearly not SE income, but I think you are correct on §1001( b )

[DANRVAN]

I think you have more research to do.  The IRS will have a strong case that there were two transactions:

1. The foreclosure.

2. An agreement not to contest the foreclosure.

While section 1001(b) addresses transaction #1, it does not address #2 where it appears the taxpayer was paid to not take action against the lender.  That is similar to the sale of a business and a noncompete agreement which are reported separately.  A noncompete agreement is similar since the seller is compensated for not taking actions that would interfere with the business and is considered ordinary income.

Was there a separate agreement not to contest the foreclosure?  How much was paid?

I am not saying you don't have a case, but it looks like you need more ammunition.

[BulldogTom]

I think you have more research to do.  The IRS will have a strong case that there were two transactions:

1. The foreclosure.

2. An agreement not to contest the foreclosure.

While section 1001(b) addresses transaction #1, it does not address #2 where it appears the taxpayer was paid to not take action against the lender.  That is similar to the sale of a business and a noncompete agreement which are reported separately.  A noncompete agreement is similar since the seller is compensated for not taking actions that would interfere with the business and is considered ordinary income.

Was there a separate agreement not to contest the foreclosure?  How much was paid?

I am not saying you don't have a case, but it looks like you need more ammunition.

How about this.  The transaction was not a foreclosure, but a short sale.  I did not do the return so I did not know that little fact until yesterday.  I think that strengthens my hand.  Now the question is, is that payment listed on the sales contract.  I don't think so, because the buyer did not make the payment, the lender did.  But it makes the transaction definitely not a foreclosure, it makes it a sale.  So the question is, was it a fair market value transaction only if the boot was supplied by the outside party to the transaction?  If my client were to testify that he would not have made the sale absent the cash from the lender, it is part of the sale, because it would not have happened otherwise.

Please keep posting your points.  And if anyone knows how to get in touch with Jainen, I would love for him to come back an rip me to shreds on this post.

Tom
Newark, CA

[DANRVAN]

The question still remains as to why the lender made the payment.  You really can't go forward with this until you see a copy of the agreement that the lender made to pay the borrower. That will carry a lot more weight than the client's testimony (as the courts often refer to as self serving testimony).

So this is a new client.  Is he being straight forward with you? Any chance he might have come looking for a different answer than what the original preparer gave him? How much did the lender pay him?

 

[BulldogTom]

Sorry, when I said I did not do the return, I meant that my staff did the return, not me personally.  We have had this client for many years.  That is not the issue in this case.

The payment was $9400.

I will ask about an agreement with the bank.  But unless the IRS gets a copy of the agreement from the bank, how do they know what it says?  Credible testimony is still credible testimony, even if it is self serving.  "I would not have completed the short sale had I not been given the additional funds" is pretty convincing.

Thanks

Tom
Newark, CA

[Cathy]

Tom, 

Was the payment listed as non-employee comp on the 1099?

Years ago, my late husband and I had a house  "offered" to us by a banker who was going to use the short-sale as a way to make money for himself also.

Did you see the "short sell" document?  Is the selling price too good to be true?  If it is, we all know about such things.  Is it possible that $18,800 was slipped under the table and split with your client and the banker?  A payment ($9,400) under $10,000 can be questionable.

Before you ask, no, we didn't buy the home because of the "scheme" that really sickened us more than anything.

And, just maybe your client's situation is legit, however, don't know if it's the lingering smell of our deal or the smell of your's client's deal....but I definitely smell something fishy!

 

Take care, 

Paranoid Cathy

[Cathy]

P.S.  The banker is now an attorney....crooked one at that!   And I remember a 1099 Misc paid to a law enforcement officer who worked wrecks.  He referred victims to a particular attorney.  Was upset that he had to pay SE tax, but when I suggested attaching an explanation to the return, he said he'd pay the SE tax.  And, yep, he is now an attorney..go figure!

Years ago, I was the office manager of a manufacturing plant that had received training funds.  To get the funds renewed, boss was to put $10k in small bills (yes, at that time, $10k was a LOT of money).  He quickly agreed until he conferred with his accountant who verified what I told him.....he would have to pay tax on the money he was withdrawing from his business!  He then declined and another business left our state!

[DANRVAN]

  But unless the IRS gets a copy of the agreement from the bank, how do they know what it says?

You have the burden of proving that the income was not taxable.  The agreement is key evidence, you don't have to present it, but I believe you would have a weak case without it.

Also, before you decide this is a case you would take to tax court, you might want to review how the judge determines what is credible:

"Credibility includes those qualities of a witness that makes their testimony believable. A witness’s testimony is evidence. The believability of evidence is one of the most important parts of a trial. There are certain factors that tend to increase a witness’s credibility, including:

• Accuracy
• Demeanor
• Lack of bias
• Motivation for testifying

A credible witness has first-hand knowledge of the case and accurately states the facts. They’re consistent in telling and re-telling their story. A credible witness is confident and knowledgeable. If a witness has an emotional or personal interest in a trial’s outcome, their credibility can be challenged for bias. On the other hand, an impartial witness has greater credibility. If a witness has nothing to gain, financially or personally, credibility isn’t a problem. There’s no reason to challenge the witness’s motivation for testifying"

 

[michaelmars]

 

I think its part of the sale transaction.  What I really don't understand, why this is at the point of tax court?  Assuming the tax is even $3000, after paying your time etc  it might be cheaper to pay. 

Edited August 14, 2015 by jklcpa
removed quote box from around poster's reply

[Abby Normal]

IRS says line 21:

http://apps.irs.gov/app/vita/content/15/15_02_010.jsp?level=basic

[Abby Normal]

A quick google search turns up abundant results.

[Max W]

We have run into several of these payments. They are mostly payments to vacate the premises.

Usually they are correctly reported in Box 3.  In the case that they are in Box 7, a Sched C-EZ is added with an offset of the total amount to Line 21.

[ILLMAS]

http://apps.irs.gov/app/vita/content/15/15_02_010.jsp?level=basic

[ILLMAS]

http://www.irs.gov/pub/irs-utl/VTA_2011-08_Cash_for_Keys_Program.pdf

[BulldogTom]

 

What I really don't understand, why this is at the point of tax court?  Assuming the tax is even $3000, after paying your time etc  it might be cheaper to pay. 

The issue is at the Notice of Deficiency stage.  The Taxpayer was late getting the 30 day letter to us.  His fault, not mine. 

When we got the 30 day letter, the response time was past.  We sent one anyway, but the NOD showed up about a week after the response went out.

It is not just the 1099 income that is coming into the equation.  Just for kicks, the IRS disallowed the EITC, which the client is fully qualified to claim (cares for his disabled brother).  It is not just the 3K, it is quite a bit more.

I don't have a great deal of hope for the client getting out of paying ordinary tax on the payment.  But I am going to present as aggressive of an argument that I can.  I think the IRS will realize they are going to lose on the SE income and the EITC.  I might just get someone in appeals who will let me get all three issues through with a no change, but that would be a miracle. 

Tom
Newark, CA

[DANRVAN]

  Just for kicks, the IRS disallowed the EITC,

Did the extra income push him out of EITC range?

[BulldogTom]

Nope.  He would get less but not eliminated.

Tom
Newark, CA

[BulldogTom]

Update:  I prepared the tax court petition and sent it to the client to mail to the Court last week.  Client calls yesterday and says there is no need because he got a letter from the IRS saying there is nothing due.

It has been obvious to me that the IRS is really behind on their correspondence replies.  My concern is that they have already issued a NOD.  I think that trumps a letter? 

Should I have the client still send the petition?

Thanks

Tom
Newark, CA

[Lynn EA USTCP in Louisiana]

I'd send the 9626 requesting the NOD be rescinded.

[DANRVAN]

 

It has been obvious to me that the IRS is really behind on their correspondence replies.  My concern is that they have already issued a NOD.  I think that trumps a letter?

The IRS does not close the door with a Notice of Deficiency; they will still accept and consider additional information.  They will  issue a written response and refer to the date your letter was received by them.

I would get a copy of the letter from the client before proceeding and find out exactly how the IRS responded. You should still be well within the 90 day window to petition the tax court. 

[BulldogTom]

On the same topic, but a little different, are any of you finding that the IRS is not sending you the client correspondence?  I have like 3 POA's out where I am working with clients at the IRS and I am not getting Rep letters from the IRS.  This is one of them.  No letters coming to me, just to the client.

Tom
Newark, CA

Edited September 15, 2015 by BulldogTom