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These Taxpayers Beat the IRS-and You Can, Too!

Fighting the IRS in court can be daunting, yet some people do prevail. Here are the most important recent taxpayer victories...CHARITABLE CONTRIBUTIONS.

A taxpayer claimed thousands of dollars' worth of deductions for weekly cash contributions to two churches.

Taxpayer position: He presented letters from the two churches saying that he had contributed a total of $8,200.

IRS position: The taxpayer did not have receipts or checks to support his deduction, so it was disallowed.

Court decision: The taxpayer's credible testimony, backed by the letters, supported his deduction. (Lionel D. Jones, TC Summary Opinion 2004-76)

Lesson: Deductions for cash contributions to charities can stand up to IRS scrutiny. It helps if the recipient is aware of these outlays and can substantiate the donations in writing. Also, taxpayers should keep a diary of weekly cash contributions to the collection plate.

ASSET TRANSFERS

A taxpayer received an IRS notice stating that he owed substantial taxes. He then set up an irrevocable trust for his children and transferred assets, including his house, to the trust.

Taxpayer position: He set up the trust because he was 68, estranged from his wife and wanted to ensure that his assets wound up with his children.

IRS position: The transfer was an obvious attempt to move assets out of its reach and should be disallowed.

Court decision: The transfer was upheld. The trust was properly funded and the children were living in the house, so these transactions were genuine. If the IRS wants to proceed further, it will have to prove that the intent of these maneuvers was to evade tax. (Jacob R. Evseroff, DC ED NY, No. 00-CV-6029, DGT)

Lesson: A reasonable estate plan can be carried out even if doing so puts assets out of reach of tax collectors.

RETIREMENT COMMUNITY COSTS

A couple living in a retirement community deducted a portion of their monthly fees as a medical expense. If medical services (access to nurses on call, for example) are included in monthly charges, some of these outlays qualify as deductible medical expenses.

Taxpayer position: They based their deduction on the percentage of monthly fees that the community earmarked for medical services.

IRS position: The formula that the taxpayers used was not valid. The deductible portion of their monthly fee had to be based on actuarial calculations.

Court decision: The IRS's actuarial method is "so complex as to defy full explanation." Instead, the percentage method used by the couple, which had been approved by the IRS in prior rulings, was permitted. (Delbert L. and Margaret J. Baker, 122 TC 143)

Lesson: Money that is spent in a retirement community may be partially deductible as a medical expense, even if the taxpayer does not use any medical services. The taxpayers lived in an independent living unit, which provided the lowest level of care in the community. There is no indication that they needed nursing care or any other medical services, yet they were allowed to deduct 32% of the monthly fees they had paid. This amounted to well over the minimum 7.5% of adjusted gross income that is required for medical expenses to be deducted on Form 1040.

Also: In prior IRS rulings, the percentage of deductible expenses was calculated per residential unit in the community. Here, the Tax Court made the calculation per resident. This means that taxpayers now can use whichever method results in the larger deduction for them.

"HOBBY LOSS" DEDUCTIONS

A business owner purchased a cattle farm decades ago and deducted operating losses for several years.

Taxpayer position: The losses were justified because he had tried several different strategies to make the farm profitable. After retiring, he lived on the farm, worked there for 50 hours a week and consulted with experts to determine how to make the business successful.

IRS position: Even though this individual was retired, he received income from other sources. He was using the ongoing losses from his farming efforts to shelter that income.Under the IRS 's "hobby loss" rules, an activity is presumed to be a for-profit enterprise if it shows a profit in three out of five years. The IRS uses these rules to deter individuals from deducting losses associated with recreational activities. This farmer had had only one small profit in 24 years.

Court decision: The taxpayer's efforts to improve operations indicated a profit motive. He read cattle-farming publications and attended seminars on raising cattle. Even though the business as a whole generated only one annual profit, there were profitable sales of parcels of land over the years.The court awarded the taxpayer a refund of the taxes paid plus interest as a result of the IRS disallowing his deductions. (Benny Mullins, DC ED Tenn., No. 3:01-CV-171)

Lesson: You can deduct losses from some ventures even after long periods without profitability. You must be able to show that you made a genuine effort to reach profitability. Selling business real estate at a profit also can demonstrate a profit motive.

IRS NOTICES

A taxpayer moved and gave power of attorney (POA) to his accountant. He filed a POA form, which included his new address, with the IRS and informed the IRS that any notices should be sent to his accountant. The IRS sent a tax-deficiency notice to his previous address, which the taxpayer did not receive.

Taxpayer position: Since he never received any IRS tax-deficiency notice, he assumed that he didn't owe the IRS any money.

IRS position: The taxpayer had not filed IRS Form 8822, Change of Address Form. Merely notifying the IRS of a change of address via "general correspondence" does not serve as an official change of address.

Court decision: An IRS POA form is not general correspondence. There is ample precedent to support the position that a POA form can officially provide a change of address. As a result, the tax-deficiency notice sent to the taxpayer's old address was not valid. (Thomas W. Hunter Jr., TC Memo 2004-81)

Lesson: A tax-deficiency notice that is not received is not valid, provided that the taxpayer has submitted either a POA form or an IRS change-of-address form.