Tax is tricky. Every day I wade through at least a half dozen court cases, memorandums, revenue rulings, revenue proceedings and Treasury Regs. We use expensive tax preparation software at our firm. Our tax preparers have post college education and credentials and an average of 20 years of experience.
So I’m always a little skeptical when I see people who insist on preparing their own tax returns if there is any level of complication at all.
In a Tax Court case memo that was released this past week, we saw just how bad it can go when you try to do-it-yourself on a more sophisticated issue like real estate professional.
In this case, the husband and wife bought TurboTax at the local Costco and set to work preparing their own return.
The husband owned and managed residential realty, while his day job was as an engineer. Although he’d been filing this way for over 15 years, the IRS only tagged two years – 2005 and 2006 – to audit. The IRS disallowed his passive real estate losses and the whole case moved to Tax Court. All along, the taxpayers maintained they were real estate professionals and thus got the full amount of the loss against their other income.
Unfortunately, the couple continued to represent themselves through the audit, appeal and even at the court case. They made some legal blunders in the case, but the court ruled in their favor and against the IRS. It seemed like the court was really trying to help this couple out with some leniency.
The problem was the taxpayer didn’t realize how his testimony pre-trial could be used against him when he flip-flopped after realizing what the answers should have been. He didn’t have documents to prove the amount of hours he now claimed to meet the real estate professional standard.
And then when it looks like he’s not only losing the real estate professional deduction with the resulting tax, penalties and interest, he gets even worst news. The IRS is going after him for the even higher negligence penalties (up to 20% on top of everything else).
They blame TurboTax software for failing to notify him as to the requirements of the real estate professional status. The Court doesn’t buy it. In fact, the Court states, “Petitioners contend that they used TurboTax software to prepare their returns for both years and that the software program is to blame for any miscalculations in their income. However, petitioners have not provided any evidence showing the information that they entered into the software program, a preliminary showing that would be required to decide whether the software program is in any way at fault for petitioners’ underpayment. See Paradiso v. Commissioner, T.C. Memo. 2005-187. Such software is only as good as the information the taxpayer puts into it. See Bunney v. Commissioner, supra at 267. We have held that the misuse of tax preparation software, even if unintentional or accidental, is no defense to penalties under section 6662. See Lam v. Commissioner, T.C. Memo. 2010-82.” T.C. Mem. 2011-69, at p. 15.”
Garbage in means garbage out. It was up to the tax preparer, or in this case the taxpayer/tax preparer, to make sure the information that was put in was correct, the laws were followed and the documentation supported the tax positions taken.
The Court goes on to say, “A reasonable person in Mr. ****’s position, understanding that the tax law governing the deductions he claimed was complex, would have consulted a tax professional instead of merely assuming that he qualified on the basis of his own conclusions.”
Bottomline: They lost the real estate professional deduction. They got hit with the regular penalties and interest plus the more onerous negligence penalties. And they weren’t successful in throwing Turbo Tax under the bus. It was the taxpayer’s responsibility to seek a tax pro and they paid a high price for failing to do so.