Can someone double check me on this - IRS Audit

[BulldogTom]

Taxpayer became mentally disabled. Took a medical leave of absense for depression and other mental illness. Was terminated from her job and applied for SS Disability in 2005. Was receiving private disability income during 2005 and 2006. During 2006, taxpayer raided her retirement plan to provide for living and medical expenses. In late 2006, administrative law judge ruled she was 100% disabled because of her mental illness, and was unable to work in any gainful capacity. Taxpayer remains disabled on SS Disability.

State of CA retirement plan issued 1099R with no known exceptions. We paid the tax, but not the 10% additional tax on the withdrawal and noted the disability exeption on the return. IRS audited and imposed the 10% additional tax. We responded with the judges ruling which included the medical testimony of her physician. The next letter was the Notice of Deficiency. We prepared the tax court petition. 3 weeks after notification of the tax court that they had recieved our petition, the Service Center that we sent our original response to sent us a letter explaining that they did recieve our letter but did not have time to respond yet.

So we get the letter from the appeals officer which included the instructions to present a corrected 1099R at the scheduled conference. Since the letter included the appeals officer's number, I called her. My position is that the taxpayer has no means under which to compel the state of california retirement plan to issue a corrected 1099R. It is also my position that regardless of what the 1099R says, my taxpayer presented proof to the commissioner on his request that satisfies the statutory requirement for the disability exception (the administrative law judge description of her disability is almost verbatum from the code on the definition of disability).

The appeals officer position is that unless the 1099R is corrected, they won't back down.

I have been looking for cases on point that the judge has ruled a corrected 1099R was not provided and this was the deciding factor, but I have not found anything. Every case seems to be decided on the strength of the evidence presented that the taxpayer was disabled.

I really thought this was a slam dunk for my client, but now I am having second thoughts. I am teleconferencing in 10 days with the appeals officer and I don't want to blow this. Is there a flaw in my analysis of this tax law? Am I missing something important? I can't beleive the appeals officer would only take a corrected 1099R as proof for the exception to apply.

Your thoughts are appreciated.

Tom

Lodi, CA

[jainen]

>>I really thought this was a slam dunk for my client<<

Nothing is a slam dunk because the IRS likes to play "chicken" (and they are really good at it). Probably they know they can't win if this gets as far as court but are betting that you aren't really prepared to handle a lawsuit. If you can present a coherent case, Appeals may back down.

Possibly the greatest weakness in your case is that she took the money out BEFORE she was ruled to be disabled. You need to get on top of the dates of actual diagnosis, including the onset of the disability. The IRS will stand firm on this--you must address it in great detail (unless of course the details don't support your position!)

Another issue the IRS succeeds with is the definition of "indefinite." You won't find any authority for your position until you turn to the definitions used for "temporary" employment away from home. That takes sophisticated analysis which is another thing the IRS is really good at. With luck the Social Security ruling will be enough because the IRS knows she went to appeals there also. Hit hard with that judge's description and hope the IRS doesn't think it was too narrow.

A case from two years ago might be helpful in the Appeals office. Unfortunately it's hard or impossible to cite in tax court because it's only a summary opinion, although you can copy its reasoning and language. In Rideaux v. Commissioner, TC Summary Opinion 2006-74, the taxpayer received a 1099-R with no known exception. The court interpreted Sec. 1.72-17A(f)(1) to mean "the impairment must be evaluated in terms of whether it does, in fact, prevent the individual from engaging in his customary, or any comparable, substantial gainful activity considering the individual's education, training, and work experience." It concluded that, "despite the distribution classification on the Form 1099-R, petitioner has provided sufficient evidence to show that he was disabled at the time of the distribution."

You might think this ruling is right on, but actually the 1099 is a red herring. The IRS WANTS you to focus on that because they know you can't get it fixed. In reality, the direct evidence of the taxpayer's own physician is far more important than the hearsay evidence of a payroll clerk.

[taxtrio]

I have had a couple of clients that took distributions while waiting for their Soc Sec Disability to be approved. They had 1099R's coded 1. We paid the 10 percent penalty and the tax (Michigan Tax also). After they received the disability determination from Social Security Administration we ammended returns showing the date of disability per Soc Sec--

The client received the retroactive lump sum payment from soc sec and began receiving the monthly payments from that time forward.

In both cases we got the 10 percent penalty refunded, and the Michigan tax refunded due to the disability--- on the distributions made AFTER the date of disability per soc sec.

I've never had a problem using this procedure.

Hope it helps you some.

P.S.

[RoyDaleOne]

I agree that 1099's are wrong more than right.

Ask the appeals officer, how is the State CA qualified to determination disability and thereby file a corrected return.

The appeals officers knows or should know that the position they have taken is wrong, relative to the 1099.

[BulldogTom]

Thank you for your thoughts.

A couple of points of clarification. The client was ruled to be disabled as of the 2005 onset which caused her leave of absence from work by the administrative law judge. At that time, she recieved private disability insurance payments until the SS Disability determination by the administrative law judge, and those private disability payments were returned when the lump sum payment was made by SS in 2007. There is no question in my mind, and is clearly stated by the administrative law judge, the exact date on which she became disabled. The withdawal took place nearly a year after that date.

>>Hit hard with that judge's description and hope the IRS doesn't think it was too narrow<<

This was exactly what I planned to do, but before I took a hard line, I wanted to get some confirmation.

>>they know they can't win if this gets as far as court but are betting that you aren't really prepared to handle a lawsuit. If you can present a coherent case, Appeals may back down<<

I have no problem with my client going to court, although we would like to avoid that scenario.

Question - we have asked for an S Case procedure. Should I change that to regular to show that we are ready to appeal if necessary? The S Case procedures work out better for a Pro Se taxpayer, and I believe that is still the case. But I know there is no appealing an S Case Ruling.

I still beleive my client is right, and the tax law backs her up. I just don't want anything that I do to cloud the issue, so I want to be sure I don't make a mis-step on her behalf that would cause her to lose.

Again, thanks for your responses. Jainen - as always, I value your knowledge and opinions.

Tom

Lodi, CA

[jainen]

>>S Case procedures work out better for a Pro Se taxpayer<<

Well, your client IS pro se unless you happen to be admitted to practice before the court. Since your whole problem is that the IRS refuses your evidence, the relaxed rules in an S-case might benefit you. For example, your doctors' statements and the Social Security ruling are technically hearsay because the authors are not present for cross-examination. Besides, the IRS knows you will accept the tax court decision as final.

By the way, you want to document all your IRS contacts and compliance so the legal burden of proof shifts to the IRS in court. Tactfully remind the Appeals officer that you won't have to prove disability, he will have to prove non-disability.

[zeke]

"administrative law judge ruled she was 100% disabled because of her mental illness, and was unable to work in any gainful capacity."

Someone please educate me. How do we expect the client to make a winning Pro Se presentation without denying her disability??

Zeke

[BulldogTom]

Which is why I would like to avoid the trial. Basically, her illness is severe depression which has caused multiple other physical and mental conditions.

Great point and well taken.

Thanks

Tom

Lodi, CA

[jainen]

>>How do we expect the client to make a winning Pro Se presentation without denying her disability??<<

The disability status refers to her inability to hold gainful employment, not that she is unable to function at all. If she is properly coached, perhaps she can page through the presentation. She can have a personal assistant, and it might even be possible to call the tax preparer as a witness to the factors used in filing the return. And if she CAN'T make the presentation, the judge will be able to correlate the medical records with what is before his eyes.

Come on, guys. You know IRS is bluffing. They just want to keep as big a backlog as possible so they can put off dealing with all the banks and brokerages collapsing.

[Jake]

Tom,

I had a very similiar situation several months ago we responded to the deficiancy notice with a letter of explanation and a copy of the disabilty ruling. I have not heard back from the client so I am assuming that the IRS is not pursuing the penalty. I will post if I hear anything different.

Jake

[michaelmars]

how much is this 10% penalty that we are talking about? i bet the hearing office will simply accept the court info. I wouldn't worry about a potential court case until after meeting with the appeals officer. If you work in a different area than the client i would move the case to your area which would mean a different irs office and thus different person to deal with if its not too late for that.

[BulldogTom]

With interest, just over 3K. The client does not have it, so if we lose, it goes probably to currently uncollectable anyway. She is living on 1000 per month SS Disability with no other assets or income.

Tom

Lodi, CA