IRS audit and preparer liability

[mekCPA]

I've come here looking for some guidance. A client recently underwent a Schedule E audit for material participation. Based on our conversations and my understanding of the situation, they were entitled to deduct losses based on the Material Participation requirements. The taxpayer had a Real Estate license, and devoted over 750 hours to the profession. Taxpayer also had a full time job. However, that full time job required approximately 1-2 days per week in the office, which is what allowed the taxpayer to devote more than half of the time worked in the full time job to this real estate business.

We defended this before the examiner, who has said that the fact that the taxpayer had a job negates being able to claim material participation, and upheld the proposed additional assessment. The taxpayer was able to get the penalties waived, so what is left owing is the taxes and interest.

Here's where I need you to be kind: no, I do not have errors and omissions insurance, and I did not use an Engagement Letter. I have definitely learned my lesson.

Never having gone through this before, I need advice.

Of course now that the taxpayer has exahausted all remedies which I have helped them with along the way, they are now stating that I should be liable for the taxes. It's my understanding (and forgive the lack of proper terminology describing liability) that if I was not negligent in the preparation and used reasonable care and have support for my position, the taxes are the responsibility of the taxpayer.

While trying to sort this out, I provided the taxpayer with possible tax attorney contact information, and the taxpayer has stated that they told her this is "black and white, by having a job, the taxpayer can never deduct material participation losses". It has progressed to the taxpayer now stating that if it was black and white, I should have known that and should be responsible for the additional taxes due. I do not agree that it is black and white.

Perhaps I am incorrect in my understanding. I'm thinking at this point I need some legal advice, so if anyone has a reference they can provide for that, I'd appreciate that too!

Like I said, please be kind, this has been a stressful situation that has escalated to an even higher level now.

Thank you!

[Pacun]

I think the lesson we learn is that while the IRS don't audit our clients, we are the BEST preparers. As soon as the IRS audits them, we are the worst. As I told Terry on another post, our clients will quickly sue us.

We should be prepared for more law suits since now there is a lot of publicity about preparers' exams, penalties and due diligence.

[rfassett]

First of all, stop beating yourself up over this. You did what you did based on your firm professional belief that your understanding of the rules is accurate.

Secondly, the tax, in my opinion, is ALWAYS the responsibilty of the taxpayer.

Third, I am not certain I understand the facts. If you are saying he had a full time job, where did he get the 750 hours. Are you suggesting he used the same hours for his job AND the real estate activity? If so, there is your fly in the ointment. The IRS (and Congress) do not condone double dipping in any of the rules as far as I know. Well, at least the rules that apply to us and our clients.

I suppose you could be sued for damages (not the tax) for lost opportunity, ie, things the taxpayer might have done differently had he been operating under the correct understanding of the rules. So yes, I would suggest seeking legal counsel and be prepared to settle for something close to the tax amount - that may be your least expensive avenue of pursuit. If my understanding of the facts is incorrect, my answer might be different.

[ILLMAS]

"The taxpayer had a Real Estate license, and devoted over 750 hours to the profession. Taxpayer also had a full time job. However, that full time job required approximately 1-2 days per week in the office, which is what allowed the taxpayer to devote more than half of the time worked in the full time job to this real estate business."

We are not here to audit our clients tax information/support, if he cannot prove he devoted 750 hours the IRS, thats on him, not on you. And I bet he was deducting losses like if there was no tomorrow. I agree, don't stress yourself, you did the return based on the information your client provided, if he didn't qualify as a R/E professional in the first place, he would of paid the taxes anyway.

[mekCPA]

@rfasset - the taxpayer worked approximately 1-2 days a week. Let's assume 2 days a week for 52 weeks at 8 hours a day. That equals 832 hours devoted to the full time job, less vacation and sick hours (yes, it's a sweet deal of a job, full time pay without full time work and also paid vacation and holidays). We provided a detailed schedule of hours devoted to the Real Estate business that more than equaled that amount. Considering a 40 hour a week job is 2080 hours a year, in my opinion, there was more than enough time to do BOTH. However, according the the examiner and all the supposed "Tax Lawyers", if you have a job that pays a full time salary, even if you do not work full time hours, the fact that you have a JOB, automatically means that you cannot also be a "real estate professional". I don't see the logic in that. Neither did my client until now.

@MAS - we DID provide a contemporaneous log showing that the hours needed to qualify as a "real estate professional" were met, however as I said to rfasset, the IRS and the "Tax Lawyers" have stated that if you work a job, it's "black and white" that you cannot also be a "real estate professional". I'm not seeing the Black and White. And I agree, if the taxpayer didn't qualify for the R/E professional in the first place, the taxes would have been paid at that time.

I just am hoping someone has some information that's "black and white" (ha!) for me on my liability. But, I guess that's why we have lawyers!

[ILLMAS]

Just because he gets paid for a full time job but only works a certain amount of hours, doesn't mean he works full time, I would not agree with the auditor position and might to take the case to appeals. Through the freedom of information act you can request the auditors work paper and see if they are doing things correct.

MAS

[rfassett]

I agree with MAS. But I think your only hope would be getting a letter from the employer stating that this taxpayer is such a good employee that the employer is willing to pay the employee full time for 2 days of work per week. That might be problematic. It might be misleading to state that it is black and white if you have a job. It might be black and white if you have a FULL TIME job. But as is always the case, the devil is in the details.

[jainen]

>>we DID provide a contemporaneous log<<

Apparently the auditor determined the log was not credible, perhaps because it conflicted with information about the other job. Did your log or time sheets cover that? Beef up your documentation of the time spent (or not spent) on the other job, and support the contemporaneous log with receipts and phone bills and signed documents and whatever else he did during those 750 hours.

So, you tried to take an assertive position for your client, and didn't get away with it this time. How is he damaged? No penalty. Interest is just for the low cost loan he got by delaying payments he would have had to pay anyway if you never tried. Time and cost of an audit, that's just an ordinary and expected part of the tax system. Once in a while they get somebody. Discount your fees for the audit in the interest of good client relations, but never pay the underlying tax.

[Cathy]

mekCPA,

I believe it was last year that KC showed us a link for free searches of tax court, etc.. cases. The search engine is Google Scholar.

For what it's worth, I googled some of the tax court cases that might help your situation. The link is below (I hope).

Take care,

Cathy

http://scholar.googl...h+Scholar&hl=en

I tried the above link and it worked for me, but the actual link was a lot longer than the one above. If you don't pull up cases relating to the 750 hours, please let me know and I can possibly email the full link to you.

Edited January 14, 2012 by Cathy

[joanmcq]

One of the reasons I think they are saying it's 'black & white' is that a full time job is generally at least 2080 hours and to meet the 'more than half your service hours devoted to real estate professions' you need to work not just 750 hours, but more than 2080 hours. And if he did not make the election to group properties, material participation must be met on each rental property, plus at least 750 hours plus more than half your service hours standard. Therefore, a full time job, unless in one of the qualified real estate professions, will make it pretty hard to meet the RE Pro. And I would have a hard time believing that someone gets paid for 'full time' when only working 1-2 days a week, and would have demanded proof before taking RE Pro for such a person. It's the kind of thing that due diligence requires us to dig a bit deeper, even though we are not necessarily auditing our clients.

So it's up to you and your client to prove he does actually have a sweet deal where he doesn't have to work the 2080 hours for full time pay and benefits. Will the employer back him up, or has he actually been shafting his employer when not in the office? Not every job requires you to be in an office, but most require you to work the hours for which you are being paid.

Also, what kinds of activities were on the real estate time log?

[Dale in IN]

mek:

Joan has hit the right point. An election has to be filed to treat all realestate activities as one.

I have checked the master tax guides from 2003 to 2012 and the ones from 2003 to 2011 say an election MAY be filed.

however 2012 says an election MUST be filed with the taxpayer's 1040.

However the 2012 says that certain taxpayers may be permitted to make a late election( Rev-proc 2011-34).

This years tax book has a court case involving a case back in 1996 & 1997 wheere the commissioner disallowed the losses because an election was not filled.

Dale in In

[ed_accountant]

It sounds like this client has turned on you. I suggest that you cut-off contact and stop worrying about the client's tax liability and take care of yourself. If he is threatening to sue you, you can't keep him as a client..

You will save alot of time and be less stressed if you drop this client and discontinue working with him.

Have you handled his audit for free? Are you helping him now for free?

Your client got the benefits of all the refunds for all the years. I do not believe you will ever be liable for someone else's tax liability. You may be liable for the interest and penalties.

You need to keep copies the records that he provided stating that he worked more than the 750 hours.. Good luck