The tax law is complicated and in a recent case IRS was found to have not presented enough evidence to support the assessment they did on an S corporation shareholder.
The Tax Court found Mr. Franklin did have basis so the IRS assessment he had a taxable dividend from his sole owned S corporation was wrong.
Basically a S corporation shareholder has basis from what was paid for the stock ownership and any debts the S corporation owed to him.
His construction company owed a creditor (ARCO) and did not pay the $1.7 million owed. In 2007 the creditor looked at Mr. Franklin’s personal guarantee of the debt and seized and sold his personal assets of $496,000 and applied that on the debt.
The court found the basis for loans owed to the shareholder (Franklin) on the 2007 form 1120S of $218,342 at Jan. 1, 2007, were paid so since the balance at Dec. 31, 2007 was zero, he basically paid the corporation debt. That meant the IRS was wrong to say he received a taxable dividend.
IRS did not satisfy its burden to produce evidence the IRS assessment was proper. It had to do with IRS “substitute for returns” (SFR) did not show IRS met the requirements of full disclosure even though he was late in filing his 2007 and 2008 returns.
The court said the record did not contain evidence needed and IRS failed to satisfy its burden of production. Mr. Franklin did have basis of the claimed pass-through loss from his S corporation.
That helped void the IRS assessment for 2007, but the court found he owed for 2008 for discharge of indebtedness income and since he did not file 2009 and 2010 returns, the IRS assessment for additional gross income from unexplained bank deposits was upheld.
This all tends to show the importance of good records, the need to file returns on time and that sometimes the IRS assessment is not correct.
It did not help that Mr. Franklin failed to include in his 2007 gross income gambling winnings of $1,200. If you are going to try to show the IRS is wrong, it is best if you don’t make other errors.
It sounds like another instance where if the taxpayer had met with IRS and gone over all the various items, this might not have ended up in court.
Did you hear? “The stability of the system is in equal imposition of taxes and the just and impartial administration of the law,” by George Boutwell, First Commissioner of Internal Revenue.
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.