Spitting nails--any help appreciated (A Long Read but worth it!) especially if you HATE DIY tax software.

[Ringers]

A current client of mine and his friend each own 50% of a large apartment building.  All income and expenses are split 50-50 on each persons individual returns and have been since 2003 when they purchased the building.

I prepared the return for the other partner in 2012 and he has prepared his own return since 2012 using a software program which we who use Intuit's ProSeries refer to as TurdoTax.

Because my client and he are thinking of selling the building, he asked me to again prepare his taxes for 2022 to get an idea of his tax liability on a sale in 2023 or 2024.  I asked him for his 2021 return in TurdoTax just to see if the depreciation and loss carryforwards on his returns were the same or very close to the depreciation and 8582 carryforwards from my client.  Both he and my client had MAGI's of over $150000 for just about all the years.  I was shocked when I looked at his 2021 return and found no 8582 at all while my client had an 8582 unallowed loss carryforward of about $170000!

 

So I asked the partner to send me the file copies of all of his tax returns from 2013 through 2021.  ProSeries lets you instantly transfer any year of TurdoTax to the same year in ProSeries, thus saving a lot of work when you have to do amendments of a poor soul who was caught in the TurdoTax web.  However, even though 2013 ,2014, and 2016 transferred flawlessly, 2019-21 all came up with errors that ProSeries could not figure out and would not transfer over.  I was able to go into the client's TurdoTax folder, and it showed all of the 2013 through 2021 tax files, pdf files, and everything else for each year EXCEPT FOR 2015.  When I clicked on 2015, the message came up that the client must not have used TurdoTax for 2015 because no file exists.  TurdoTax technical support cou9ld not get their screen sharing program nor theoir BACKUP screen sharing program to work, but they assured me that 2015 was NOT done with TurdoTax!!!

Later the agent said that Intuit only stores 10 years of files, so that 2015 would no longer exist anyhow???  When I reminded her that 2015 was less than 10 years ago, she put me on a brief hold to confer with an associate.  When she came back, she said that she had erred and that Intuit only kept 7 years rather than 10.  Doing the math for her again, I show3ed her that 2015 should still be there.  She could not screen share with me--if she had been able to she would have seen ALL of the actual tax files dating back to 2013 neatly arranged in my client's file!!!  The fact that I was being lied to by TurdoTax really got to me and I said "Look, what we have here is a $150000 error on the part of your program, which will represent approximately $50000 of Federal and State tax reductions for my client.  Under the 7 Year 100% TurdoTax Guarantee, they are going to have to write him a sizeable check, since even after I amend all of the years from 2016 through 2021, three of those years are now closed for refunds.  Since the year n question, 2015, "lost" that large loss carryforward, the IRS may not even allow us to recapture that loss at all!!!  She then disconnected the call after an hour on the phone as a conference call with me, her, and my client.  We had to call back and go through all of the same material again.  Finally, I got an agent to escalate the call to the managing supervisor of TurdoTax, "James."  James was able to get the screen sharing to work, finally, and I showed h8m the files in my clients TurdoTax folder.  James also noted that for 2015, no files existed and so he must not have filed with Turdo in 2015.  Fortunately, my client had saved a 2015 pdf of his return which I opened on my screen for James.  There was about a minute of silence.  The 2015 pdf had as its first page the 2015 1040 with a big red TurdoTax emblem on the page.  Page 44 of the pdf stated "intuit has efiled you return on April 6, 2016 at 8:06 PDT with the IRS.  Farther down the page was the statement that "the Intuit server has received notification from the Internal Revenue Service that your Federal 1040 has been accepted."

Then I showed him the 8582's from 2014, 2015, and 2016.  A loss of $142196 was shown as unallowed on the 2014 return.  The loss carried to the 8582 for 2015 on the pdf was EXACTLY - $142196.  The 2015 current rental loss was -$12834.  The total loss available was thus -$155030.  Based on his MAGI, the allowable loss on the 2015 return was -$10730 (remember this number!).  His unallowed loss to be carried forward to 2016 was therefore -$144300.

 

I then showed him the TurdoTax 8582 for 2016.  It shoed a prior year unallowed loss of -$10730!!!!!!!!!!!!!!  Over $133570 of rental loss carryforward had been WIPED OUT BY TURDOTAX!!!!

Another long moment of silence by James, who finally said "I am surprised you have been so calm with us.  I would be out of my mind!"  He understood the program, he understood accounting, he understood rental losses, and he understood that he was not high enough on the chain to do anything about it.  I also mentioned to him if the 2015 program had glitched for other rental entrepreneurs and perhaps there was a whole niche of TurdoTax users who had not noticed their accumulated rental losses evaporating because it was not their job to know tax.  Maybe my client's removal of $133000 of useable loss was just one of perhaps hundreds or thousands of Turdo users.

 

We set up a conference call to the number he had given us, now having been on the phone for over 4 hours straight having gone through 3 battery recharges on my cordless phones.  Nevertheless, I set up a call to Intuit Corporate.  The phone was answered by a machine telling us that we should probable be talking to TurdoTax, or Quickbooks, or Mint, or other thins, but to leave us alone.  It then put us on a hold, we got to hear 7 minutes and 4 seconds of music, after which we were cut off.

 

I called the number again today, was told again to bother TurdoTax or one of the other Intuit entities, and then told to press 0 for an operator to continue the call the Corporate.  After 15 rings, the phone was answered by A SECURITY OFFICER.  He said I had the correct number, but no one from corporate was in (!!!!!) and there was no way he could transfer the call.

I then wrote an email to an address which is supposedly someone in corporate per the Intuit website, so I will see what happens next.

 

Thanks for letting me vent and letting my blood pressure get below stroke stage.  Any suggestions?

As always, I value your combined wisdom and experience.  I myself have been doing tax returns since 1971 and began using ProSeries when it was called "Chipsoft" before Intuit got their greedy hands on it.

 

Ringers

 

 

[BulldogTom]

I don't know what to say.   Is a 3115 an option at all?   

Tom
Longview, TX

[Lee B]

I get the impression that no Form 1065s were ever filed, that both 50% owners have been treating it as a joint venture?

My understanding of a joint venture is a short term project or short term objective.

 

[Lion EA]

Or, a jointly-owned rental building.

[ILLMAS]

Please add my fee to your fees for reading this and as the young whipper snappers say now a days, have TT help you.

[Ringers]

Tom- I looked at a 3115 which I have filed in the past for clients that had not depreciated their rentals, but I can't find any code for the 3115 that would qapply to a software error screwing up the loss carryforward.

 

There have been no 1065's ever filed.  Each T/P reports rent and all expenses at 50%.  They started the jointly owned rental a few years before they had professional help.

This year was running soooooo smoothly for me.  My biggest gripe until this happened was having to remove staples from my clients' docs before scanning with my Scansnap!  Was thinking of instituting a Staple Surcharge of $1 per staple. 

[Lee B]

It's been 3 or 4 years since I posted this story.

Early in my practice I picked up 3 brothers as clients. Two brothers were restaurant owners and the third was a W 2 employee .

Together the 3 brothers each owned 1/3 of a commercial rental building. The CPA who previously prepared their tax returns

treated the rental as a joint venture with each brother reporting 1/3 of the income and expenses on their personal returns.

I followed along and did the same for two years until the IRS intervened by sending the 3 brothers a letter insisting that they had to file a Form 1065.

They backed that up by saying that the "monthly late failure to file penalties" would apply.

 

[Ringers]

The two partners have held the property as 5-/50 ownership since its purchase in 2003 and plan to sell in either 2023 or 2024.  I will keep my fingers crossed that even with the increased number of "knowledgeable" IRS agents it will still slip under the radar for the next year or two.

 

Ringers

[Sara EA]

Ringers, this is clearly a problem for after tax season.  Just the time you spent on the phone could have produced a tax return or two or three.  Put the new client on extension and deal with it in May.  Warn him that your fee will be humongous.  I would also continue with the joint venture; even though it's not correct the bottom line should be the same.  I would worry more about having to explain those huge losses.  Are they for real?

[Lion EA]

From the Partnership instructions: A joint undertaking merely to share expenses isn't a partnership. Mere co-ownership of property that is maintained and leased or rented isn't a partnership. However, if the co-owners provide services to the tenants, a partnership exists.

[jklcpa]

13 hours ago, Sara EA said:

clearly a problem for after tax season.  Just the time you spent on the phone could have produced a tax return or two or three.  Put the new client on extension and deal with it in May

This may not be a good idea considering the dollars involved. Unless the taxpayer requested an extension for the 2019 year, at a minimum the 2019 return needs to be analyzed to determine the effect of correcting the carryforward. Note - the 2019 original filing date was extended from 4/15 to 7/15/20 because of COVID, so there is a little extra time before the 2019 tax year is "closed" for any claim of refund. Anyway, the point is that there is not much time to amend and correct 2019.

Ringers, also to consider: if your client wants to hold TT to their 7-year guarantee, that runs from 7 years starting with the date the return was actually filed, so if the 2015 return was filed prior to March 1 or today, depending on how you want to look at your client's notification to TT of the error, your client's guarantee period for the 2015 return may have already lapsed.

Client may have to get an attorney involved in this. Sounds messy.

 

[jklcpa]

I'll post more thought on this after some more sleep and after the sun comes up.  

[Lee B]

7 hours ago, Lion EA said:

From the Partnership instructions: A joint undertaking merely to share expenses isn't a partnership. Mere co-ownership of property that is maintained and leased or rented isn't a partnership. However, if the co-owners provide services to the tenants, a partnership exists.

The big problem with this approach is that it only works as long as both co owners are both happy and are working together well.

There are no legal documents or agreements spelling out rights and responsibilities.

The only resolution for disagreements is retaining an attorney and going to court.

I have already experienced the downside to this approach several times.

[Ringers]

Thanks Judy and all others!  I will definitely file all of the amended returns before 4/15 of this year so as not to lose the ability to receive refunds for 2019.  Unfortunately, I know the refunds for 2016,7, and 8 will be forfeit.

I wonder, since the error in recording the losses properly occurred in 2016 (a closed year) if the IRS has the potential of disallowing the entire additional loss carryforward?

The loss carryforwards are legitimate, as the building in an $800000 multi unit building with a business management company handling the rents and most repairs.  The depreciation, mortgage interest, and taxes have exceeded the rental income since inception and both partners have usually been over the MAGI limit since 2003, so very few of the losses have been deducted on either partners' returns.

 

Ringers

[jklcpa]

Now that the sun is up and thinking more clearly, that is what I was to suggest: to file all of the amendments correcting the loss carryforwards.  I would also make sure to show the losses on an AMT basis even in those are all the same numbers.  You don't want the IRS bouncing it because those calculations weren't included with the amendments.

I'm going with the idea that this is similar to someone that has a cap loss c/o that is below filing threshold in the immediate following year and then a subsequent year does need to file again. That non-filed year doesn't mean that the loss c/o no longer exists, it only means that the calculation of carryover in the nonfiled year wasn't made. The loss still exists, and when filing again, is shown at the proper amount.  In the case of Ringer's client, a figure was entered incorrectly that should be fixed, and the additional loss does exist which should be plainly evident when comparing the 2015 and 2016 returns as originally filed.

I also see that the main error of carryforward occurred in the 2016 year and not in the 2015 year as I'd written above, so that buys about a year to hold TT responsible with its 7-year guarantee.  With TT reps saying they can't find the return in the system, is there any chance that this same thing happened when the client tried to access the file and complete his return?  I can foresee TT trying to wangle out of this by saying the the client had typed that loss carryforward number of $10K into its system and creating the error himself.

[DANRVAN]

From what I am following in this post, a disallowed passive loss carryforward loss was dropped in 2016.

 

The property connected to the loss might be sold and free up suspended losses.

 

Even though 2016 is closed for refunds or assessments; It my understanding that the closed years can be amended to bring a carryover forward to an open year. 

[jklcpa]

15 minutes ago, DANRVAN said:

From what I am following in this post, a disallowed passive loss carryforward loss was dropped in 2016.

 

The property connected to the loss might be sold and free up suspended losses.

 

Even though 2016 is closed for refunds or assessments; It my understanding that the closed years can be amended to bring a carryover forward to an open year. 

Yes, exactly!

 

[Ringers]

Thanks Judy and Dan,

I am going to file 1040-X returns for 2015 through 2021.  The property has not been sold yet.  The taxpayer has retired, and some of the losses allowed in some of the years will exceed his income for the year creating NOL's for the excess rental losses claimed.

My major concerns were these:

IRS would try to disallow the entire loss carryforward due to tax year 2015 being closed and

TT would try to stonewall us.

 

You have allayed my fears of #1, and for #2 TT claims no return was filed in 2015 but we have a pdf that the taxpayer printed showing the bright red TurboTax logo on page 1 and on a subsequent page stating that Intuit has efiled your returns on April 8, 2016 at 8:06 PST and later on the page the date and time stamp when Intuit received notice from the IRS of acceptance.  I think we are on solid ground there.

 

Thanks for your thoughts!

 

Ringers

[Abby Normal]

I wouldn't amend anything that doesn't get a refund. I'd go back and redo each year properly, to determine the current passive loss carryover, then just do 2022 based on that.

The IRS doesn't keep track of carryovers so they won't complain when one just shows up.

[BulldogTom]

1 hour ago, Abby Normal said:

I wouldn't amend anything that doesn't get a refund. I'd go back and redo each year properly, to determine the current passive loss carryover, then just do 2022 based on that.

The IRS doesn't keep track of carryovers so they won't complain when one just shows up.

HMMMMM.....I like it but it scares me.   Safer to amend I think.   Need to pass this by the Jedi council to see what the Force says.   Wimps like me want to have all my returns accurate before I start fighting the Dark Forces of the IRS.

Tom
Longview, TX

[jklcpa]

1 hour ago, Abby Normal said:

I wouldn't amend anything that doesn't get a refund. I'd go back and redo each year properly, to determine the current passive loss carryover, then just do 2022 based on that.

The IRS doesn't keep track of carryovers so they won't complain when one just shows up.

No, they should be amended.

https://www.thetaxadviser.com/issues/2015/sep/statute-of-limitation-tax-carryovers.html

There are 2 cases presented in the article that precedes this quote, but without a C&P of the entire article, the following excerpt hits the basic idea:

Quote

The IRS has consistently followed and agreed with this taxpayer-favorable interpretation. In Rev. Rul. 81-88, a taxpayer failed to claim a deduction it was entitled to, but did not realize this until after the statute of limitation had expired for the year the deduction should have been claimed. The IRS ruled that because the deduction increased an NOL carryforward to an open tax year, the taxpayer was allowed to use the NOL carryforward to reduce the taxpayer's income in that open tax year. The IRS continues to refer to Rev. Rul. 81-88 in Internal Revenue Manual Section 4.11.11.6(10), explaining that "errors in a closed year are corrected for purposes of determining the taxable income of an open year."

 

[jklcpa]

Here's the whole article:

Statute of Limitation for Tax Carryovers  by David J. Holets, CPA, Indianapolis,  September 1, 2015

It is not unusual for a taxpayer to make an error on a return that results in a misstatement of a net operating loss (NOL) or a credit that is then carried forward. In some cases, these mistakes might not be noticed until after the statute of limitation for the tax year generating the NOL or credit carryover is closed.

Example: W, a C corporation, generated a $10 million NOL and a $1 million Sec. 41 research credit carryover in 2010. W could not carry back either amount. Each year from 2011 through 2014, W had taxable income. In 2015, W expects to use the allowable portions of its 2010 NOL and research credit carryovers. When preparing its 2015 tax return, W discovers the 2010 NOL carryover had been understated by $1 million and the research credit carryover had been understated by $500,000. The statute of limitation for 2010 is closed. Does W have any options to adjust the carryover amounts from 2010?

Statute of Limitation: NOL Carryover

The statute of limitation to assess income tax under Sec. 6501 is three years after the date a tax return is filed. The statute of limitation for filing a claim for refund under Sec. 6511 is the later of three years from the date a tax return is filed or two years from the date the tax is paid. Sec. 6511(d)(2) further prescribes that in the case of an NOL or capital loss carryback, the statute of limitation to claim a refund is three years from the filing date of the return that originates the carryback claim.

The statutes do not, however, address what statute of limitation applies to carryover items. Although the answer initially might seem straightforward, case law and IRS guidance yield a different answer from what might be expected.

One of the earlier cases to address how the statute of limitation applies in a similar situation, adjustment of a carryback NOL involving a closed tax year, is Phoenix Coal Co., 231 F.2d 420 (2d Cir. 1956). In Phoenix Coal, the taxpayer had NOLs in 1947 and 1948. The taxpayer timely filed NOL carryback amended returns to use the losses in 1945 and 1946. The NOLs eliminated all of the taxpayer's income in 1945 but only part of its income in 1946.

After the statute of limitation for 1945 closed but before the statute of limitation for 1946 closed, the IRS recomputed the taxpayer's income for 1945. This recomputation did not result in any additional tax assessment for 1945, but it reduced the NOL carryback available for 1946. The court allowed the IRS to reduce the NOL carryback on the 1946 tax return even though the adjustment related to a closed tax year. The court reasoned that the statute of limitation for the assessment of tax does not apply until the year items are used against taxable income.

This theory is raised again and more clearly stated in later case law, including Barenholtz, 784 F.2d 375 (Fed. Cir. 1986), in which the IRS was permitted to recompute taxable income in closed tax years to adjust NOL and charitable contribution carryovers to open years.

As interesting as the results in Phoenix Coal and Barenholtz might be, they are of little benefit to taxpayers, as they address the statute of limitation only on carryover amounts for purposes of the IRS's assessment of tax. Another case, Springfield St. Railway Co., 312 F.2d 754 (Ct. Cl. 1963), allowed a taxpayer to adjust its NOL carryback amount absorbed in a closed year to claim a refund in an open one. The taxpayer recomputed its income in the closed year by applying an abandonment loss it discovered it had been entitled to, decreasing its NOL carryback in that year. The taxpayer correspondingly increased its NOL carryback amount for the following tax year, which was still open, resulting in a refund. The court concluded that the same statute of limitation for carryback items should apply to taxpayers requesting a refund as to the IRS when assessing tax.

The IRS has consistently followed and agreed with this taxpayer-favorable interpretation. In Rev. Rul. 81-88, a taxpayer failed to claim a deduction it was entitled to, but did not realize this until after the statute of limitation had expired for the year the deduction should have been claimed. The IRS ruled that because the deduction increased an NOL carryforward to an open tax year, the taxpayer was allowed to use the NOL carryforward to reduce the taxpayer's income in that open tax year. The IRS continues to refer to Rev. Rul. 81-88 in Internal Revenue Manual Section 4.11.11.6(10), explaining that "errors in a closed year are corrected for purposes of determining the taxable income of an open year."

Based on this analysis, in the above example, W can adjust its NOL carryover to 2015 by the $1 million understatement of taxable loss for 2010, even though the statute of limitation for 2010 is closed. However, it should note that the same rules apply to IRS adjustments of the 2010 NOL that might reduce the NOL carryover.

Statute of Limitation: Tax Credits

Later, in Rev. Rul. 82-49, the IRS expanded the application of Springfield to the investment credit. In that guidance, the taxpayer placed in service in 1976 property for which it was entitled to an investment tax credit, but it did not timely claim the credit. Although the statute of limitation for 1976 had closed by the time the taxpayer noticed its error, so that no claim for refund could be filed for 1976, part of the credit would have been available as a carryover to open tax years. The taxpayer was allowed to amend those open tax years for the carryover.

Although this IRS guidance concerns the now mostly expired investment tax credit, it should apply to other credits as well. The investment tax credit is part of the Sec. 38 general business credit, so other general business credits, including the Sec. 41 research credit, should be eligible for a similar adjustment. Therefore, W in the example would be allowed to correct not only its NOL carryover from 2010 but also its research credit carryover from 2010.

Closing Comments

Although case law and IRS guidance establish the opportunity to adjust in open years carryover amounts arising from closed years, practitioners should be aware of a few important issues. First, none of the IRS guidance or case law addresses how to adequately notify the IRS of an adjustment to a carryover amount made for a closed tax year. If a taxpayer needs to file an amended return to claim the adjustment to a carryover item, disclosing the issue in the explanation section of the amended return should be sufficient. However, if the change is discovered before an amount from a carryover item is used, it is unclear what, if any, explanation must be provided for the change in carryover amount. It might be advisable to include a short written statement in the year the carryover item is adjusted, to explain the reason for the change.

Second, state law might not necessarily conform to federal law. Although many states adopt the Internal Revenue Code, they frequently establish their own rules regarding tax return statutes of limitation. It is not unusual for a state to have a four-year statute of limitation. Furthermore, because the statute of limitation on carryovers is not formally established in the federal statutes, states may consider this an interpretation of the law and thus not conform to the federal treatment.

Finally, currently, there is no guidance that would allow a passthrough entity to adjust an item of taxable income in a closed year. Using the previous example, assume W is an S corporation with one owner instead of a C corporation. Assume 2010 is a closed year for both W and its shareholder and that the carryover amounts for the shareholder are identical to those listed for W in the example. There currently is no clear precedent that would allow W to adjust or amend its Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., for the closed 2010 tax year. The shareholder may not be able to adjust its carryover item without receiving a timely filed Schedule K-1 from W, including the full amount of the NOL and research credit.

Businesses using loss and credit carryovers should take note of these rules. Taxpayers have an opportunity to favorably adjust carryover items from closed years, but they need to remember the IRS can use the same rules to reduce carryover items.

Editor Notes

Howard Wagner is a director with Crowe Horwath LLP in Louisville, Ky.

For additional information about these items, contact Mr. Wagner at 502-420-4567502-420-4567 or [email protected].

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

[Abby Normal]

1 hour ago, jklcpa said:

No, they should be amended.

https://www.thetaxadviser.com/issues/2015/sep/statute-of-limitation-tax-carryovers.html

There are 2 cases presented in the article that precedes this quote, but without a C&P of the entire article, the following excerpt hits the basic idea:

 

I don't think that applies to passive loss carryovers. I stand my not amending.

[Ringers]

Thanks again, all, for the input.  I like the idea of not amending the non-refund years, but I'm afraid I am just like Tom and want a perfect paper trail from point A to points B,C,D,E, and F if I am ever called upon to justify it.  On a more practical note, it is easier to bill the client for an amended return than it is to bill for hours of account9ing time in creating a spreadsheet that leads to the amended return.

[mcbreck]

19 hours ago, Abby Normal said:

I wouldn't amend anything that doesn't get a refund. I'd go back and redo each year properly, to determine the current passive loss carryover, then just do 2022 based on that.

The IRS doesn't keep track of carryovers so they won't complain when one just shows up.

We forgot a loss carryforward on an 1120S and you can't efile an amended return that only has a carryforward correction. We added it to the next year's return with a note and it was never questioned by the IRS. I'm pretty sure we did mail in an amended return but I'm pretty sure we were told it wasn't required. I like the idea of amending if at all possible just to show the trail.