On April 5, 2022, the Tax Court issued a Memorandum Opinion in the case of Salter v. Commissioner (T.C. Memo. 2022-29). The primary issues presented in Salter v. Commissioner were (i) whether the Code section providing exception from imposition of additional tax resulting from early distribution from retirement plan applied; and (ii) whether the taxpayer was entitled to itemized deductions when he failed to file a return, and the IRS filed a substitute for return on his behalf.
Held: Nope on both counts, Shawn.
Background to Salter v. Commissioner
The IRS issued a notice of deficiency for 2013 to the petitioner after he failed to file a Federal income tax return for that year. He did not dispute the items of gross income shown in the notice of deficiency. However, he did dispute his entitlement to itemized deductions, the computation of an IRC § 72(t) additional tax for an early distribution from a retirement plan, and his liability for a failure-to-file addition to tax under IRC § 6651(a)(1).
During the first half of 2013, the petitioner resided in Arizona and was employed by Home Depot as a district loss prevention manager. His tasks included training employees in loss prevention techniques and policies, auditing inventory, and conducting investigations of shoplifting and other thefts.
The petitioner worked from home but traveled regularly by car to the stores under his supervision. Home Depot offered reimbursement for his travel expenses at a mileage rate, but he declined to seek reimbursement because he believed that claiming such costs on his tax return “would give [him] a bigger refund.” He produced no evidence (such as logs or odometer readings) to substantiate his work-related travel.
The petitioner was laid off in mid-2013. To tide himself over during his period of unemployment, he requested from Northern Trust and received during 2013 a distribution of $37,647 from his retirement plan. He had not reached the age of 59½ by that time.
Having received no return from the petitioner for 2013, the IRS prepared a substitute for return using third-party reporting as its basis.
On March 23, 2020, the IRS issued a notice of deficiency to the petitioner asserting that the retirement distribution was taxable and asserting a failure to file penalty on the basis that…well, he had failed to file his damn return. The IRS computed a tax of $13,195 and determined an additional tax of $3,765, calculated as 10% of the early distribution from his retirement plan under IRC § 72(t).
After receiving the notice of deficiency, the petitioner informed the IRS of his belief that he had filed a return for 2013 using H&R Block software. The IRS records showed that no return had been submitted, and the petitioner was unable to produce, from H&R Block or his own files, a copy of a return or evidence of its filing.
The petitioner then prepared, in April 2021, a Form 1040, U.S. Individual Income Tax Return, for 2013, reporting all items of income as shown on the notice of deficiency, but claiming itemized deductions for state and local taxes, home mortgage interest and insurance premiums, charitable contributions, and $10,500 in unreimbursed employee expenses including vehicle costs.
On this Form 1040, the petitioner admitted that he had received an early distribution of $37,647 from his retirement plan. However, he computed the 10% additional tax on that sum as only $3,200 by offsetting the alleged unreimbursed medical expenses against the distribution when computing the additional tax.
The IRS received third-party reports showing that the petitioner had paid $1,652 of state and local taxes, $10,652 of home mortgage interest, and $1,091 of mortgage insurance premiums during 2013. The petitioner, however, supplied no documentation, during the IRS examination or at trial, to substantiate any of the other deductions he claimed. Indeed, the petitioner “admitted that he had estimated these amounts.”
He testified that he originally had documentation for his expenses, but that he had thrown those records away when he moved to California in 2017, believing that there was no need to keep the records for more than three years.
Editor’s Note: Keep your freaking records. For at least six years. Hell, put them in a shoebox and stuff them behind your loafers in your closet. Just keep the damn records.
The IRS, to no one’s surprise (except, perhaps, the petitioner) did not accept the Form 1040 for filing.
No Itemized Deductions if No Return is Filed
Deductions are a matter of legislative grace, and taxpayers bear the burden of proving their entitlement to any deduction claimed. A taxpayer must show that he or she has met all requirements for each deduction and keep books or records that substantiate the expenses underlying it. Failure to keep and present such records counts heavily against a taxpayer’s attempted proof.
Editor’s Note: See previous Editor’s Note.
IRC § 274(d)(4) sets forth heightened substantiation requirements with respect to “listed property.” As in effect during 2013, “listed property” included “any passenger automobile.” No deduction is allowed for vehicle expenses unless the taxpayer substantiates, by adequate records or sufficient evidence corroborating his own statements, the amount, time and place, and business purpose for each expenditure.
Editor’s Note: See first Editor’s Note.
All the deductions that the petitioner claims are itemized deductions. IRC § 63(e)(1) provides that, “[u]nless an individual makes an election under this subsection for the taxable year, no itemized deduction shall be allowed for the taxable year.” IRC § 63(e)(2), captioned “Time and Manner of Election,” provides that “[a]ny election under this subsection shall be made on the taxpayer’s return.” In certain circumstances a taxpayer may make “a change of election with respect to itemized deductions,” but only when a return was previously filed.
The statutory direction that an election to itemize deductions “shall be made on the taxpayer’s return” is mandatory. “Thus, if an individual fails to file a return, he has made no election to itemize his deductions.” If no return is filed, and, “as a result, the IRS prepares a substitute return, then the individual has made no election and may not claim itemized deductions.”
The petitioner doggedly insisted that he did timely file a return for 2013, but he offered no “evidence” of “any kind” to support that assertion.
Although he “allegedly” used H&R Block software to prepare the return, he failed to produce a copy of any return—from H&R Block or from his own files.
The Tax Court found that the petitioner did not file a return for 2013, that he made no election to itemize deductions as required by IRC § 63(e), and that he accordingly was not allowed any itemized deductions.
The petitioner concedes that he received a taxable distribution of $37,647 from his retirement plan in 2013 and that this was an “early distribution” because he was younger than 59½ at the time. In such circumstances IRC § 72(t)(1) imposes an additional tax equal to 10% of the distribution.
However, the additional tax does not apply “to the extent such distributions do not exceed the amount allowable as a deduction under IRC § 213“ for medical expenses. This exception is available “without regard to whether the [taxpayer] itemizes deductions for such taxable year.”
In computing the additional tax, the petitioner reduced the distribution by $5,647 on account of alleged unreimbursed medical expenses. The petitioner testified that he consulted doctors during 2013 and paid medical insurance premiums after he lost his job. Once more, however, he submitted no documentary evidence of any kind to support these assertions.
In any event, this exception is available only for medical expenses “allowable as a deduction under IRC § 213.” During 2013, medical expenses were deductible under IRC § 213 only to the extent they exceeded 10% of the taxpayer’s adjusted gross income. The petitioner conceded at trial that his medical expenses, even if substantiated, did not exceed this 10% floor.
Because the petitioner failed to substantiate his medical expenses, and because they do not exceed the 10% floor, he cannot qualify for this exception. The IRS, therefore, correctly determined an additional tax of $3,765 under IRC § 72(t)(1).
Footnotes for Salter v. Commissioner
- See IRC § 6020(b). ↑
- Tax Court Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). ↑
- IRC § 6001; Roberts v. Commissioner, 62 T.C. 834, 836 (1974). ↑
- Rogers v. Commissioner, T.C. Memo. 2014-141. ↑
- IRC § 280F(d)(4)(A)(i); Treas. Reg. § 1.280F-6(b)(1)(i). ↑
- See IRC § 274(d); Temp. Treas. Reg. § 1.274-5T(c). ↑
- See IRC § 63(e)(3). ↑
- See Jahn v. Commissioner, 392 F. App’x 949, 950 (3d Cir. 2010) (quoting § 63(e)(2)), aff’g per curiam T.C. Memo. 2008-141. ↑
- George v. Commissioner, T.C. Memo. 2019-128, 118 T.C.M. (CCH) 294, 296, aff’d per curiam, 821 F. App’x 76 (3d Cir. 2020). ↑
- Id.; see Zaklama v. Commissioner, T.C. Memo. 2012-346 (“Having failed to file returns and thereby having failed to elect to claim itemized deductions on their returns, [the taxpayers] are not entitled to do so in these proceedings.”); Murray v. Commissioner, T.C. Memo. 2012-213; Salati v. Commissioner, T.C. Memo. 1989-192. ↑
- See § 72(t)(2)(A)(i). ↑
- IRC § 72(t)(2)(B). ↑
- Id. ↑
- See IRC § 213(a). ↑