An insurance consultant’s clients are currently primarily accountants. Nonetheless, he prepared his own return for tax years before he had these clients. He admitted to the Tax Court that he made a lot of mistakes when he prepared the return. He claimed payments to his former spouse were deductible. He claimed various business expenses, including interest payments, were deductible. Unfortunately, these deductions were disallowed:

  • It was true that he made these payments to his former spouse, but they were made pursuant to the couple’s oral agreement and not to a court decree or written separation agreement. Thus under tax law they were not deductible.
  • It is also true that he made certain payments, such as interest, but the amounts paid to the lender did not match amounts reported on the returns. What’s more, there were no business records for the loan, any loan statements, or any loan repayment schedules. Without such documentation, it was impossible to determine whether the payments were made on the original loan as he claimed. His claimed deduction for “other expenses” was supposed to be a net operating loss carryforward, but it was entered on the wrong line of the tax return. Again, these deductions were disallowed.

Because of these errors, the IRS imposed an accuracy-related penalty for a substantial underpayment of tax. This penalty applies if the understatement of tax exceeds the greater of $5,000 or 10% of the tax required to be shown on the return. To avoid the penalty, the burden is on the taxpayer to prove that there was reasonable cause and that he acted in good faith. In this case, he said that his software—TurboTax—lured him into claiming some of the deductions (the “TurboTax defense”). The Tax Court dismissed this argument as meritless (Barry Leonard Bulakites, TC Memo 2017-79). He took deductions he shouldn’t have and overstated certain losses. He can’t blame the software, because it is only as good as the information inputted into it.