Ronald and Judy Mills recently lost in Tax Court, but when you think about it maybe they didn’t do so bad overall. The issue in the decision was whether they should be subject to an accuracy penalty. One of the ways that you can avoid an accuracy penalty is by showing that you relied on a qualified professional to prepare your return. The Mills had been using someone named Robert Sandlin. He seemed qualified:
In 2000 Mr. Sandlin worked briefly for a company called Tally & Co. He left Tally & Co. in 2000 and was self-employed before joining later that year a company named United Revenue Service. Mr. Sandlin stayed with United Revenue Service until 2006 when he went back to Tally & Co. In 2007 Mr. Sandlin joined a company called Strategic Tax & Financial Services Corp. Mr. Sandlin was an accountant but not a certified public accountant or an attorney. He was, however, an enrolled agent until August 3, 2007, when his status became inactive.
I hate to admit it but if I had to choose between a random CPA and a random enrolled agent to know something about taxes, I’d pick the enrolled agent. Attorneys ? Based on some of the Tax Court cases I read, like the recent one involving the great F. Lee Bailey, attorneys should not be allowed to prepare their own returns much less those of other people. So, case closed. The Mills should have been out from under the penalty since they used an enrolled agent. Well maybe it is worth considering what he recommended to them.
As stated, Mr. Sandlin assisted petitioners in forming the three LLCs. Petitioners relied on Mr. Sandlin to establish depreciation schedules for the assets held by the LLCs. Mr. Sandlin also told petitioners that they could amortize the value of Mr. Mills’ contribution of his life, time, and expertise in real estate management.
Petitioners and Mr. Sandlin valued this contribution at $1.75 million per LLC. Thus, the LLCs claimed amortization deductions of $116,667 per year per LLC. This practice started in 2000, and the amortization schedule was 15 years. Before the 2007 taxable year, petitioners had taken amortization deductions of $116,667 per LLC for seven years, about $2.45 million in total. Respondent issued a notice of deficiency on September 3, 2010, and petitioners timely petitioned this Court for redetermination.
There are rulings that indicate that it is possible to sell your personal goodwill to someone. You will likely get capital gains treatment and the buyer will have an intangible asset amortizable over 15 years. You cannot, however, get basis in your own life by contributing it to a partnership. Apparently even the Mills got that, since they were only appealing the penalty. They lost. Although I don’t disagree with the Tax Court decision, there is one part of the analysis I find troubling:
First, petitioners must show that Mr. Sandlin was a competent professional. At some point, Mr. Sandlin was an enrolled agent, a status which can tend to show competence. But Mr. Sandlin was no longer an enrolled agent when he prepared and filed petitioners’ return for the 2007 taxable year. Petitioners provided no evidence that Mr. Sandlin was an enrolled agent at the time he first advised them to take the amortization deductions. Rather, the parties have not been able to discover when Mr. Sandlin received enrolled agent status. We cannot find that Mr. Sandlin had special competence simply by virtue of a status he may not have had at the time the original amortization deductions were taken and certainly did not have at the time the 2007 income tax return was filed.
How many people check whether professionals have had their tickets pulled, when they go back to them year after year. Thanks to the web, it is easier. Here is mine in case you are worried. The National Association of Enrolled Agents has a find an enrolled agent site, but I couldn’t figure out if it is limited to Association members. I did not find anything on irs.gov that allows you to check, although you can get a complete list for $35. Regardless, it would seem that the IRS should have known one way or the other. I’m probably missing something about trial procedure.
Then there is the “too good to be true” argument.
Even Mr. Mills stated that he was skeptical about taking $350,000 worth of deductions per year for the contribution of his own life to the LLCs. Petitioners stated that Mr. Sandlin provided them copies of cases and statutes purporting to support such amortization deductions, but they were unable to produce these sources of authority. Given petitioners’ failure to investigate Mr. Sandlin’s professional and educational background, the “too good to be true” nature of the advice, and their inability to produce the authority they allegedly received, we cannot find that petitioners relied in good faith on Mr. Sandlin’s advice.
Boy, would I ever like to study those “sources of authority”. It is a real shame that Mr. Mills could not find them.
Then there is the “valuation issue”:
While Mr. Sandlin was the mastermind behind these amortization deductions, Mr. Mills provided the underlying valuation. Mr. Mills came up with the $1.75 million per LLC figure, which was based on what he hypothetically would have charged the LLCs for his services over the years. Petitioners have not provided any evidence showing the accuracy of this valuation or how Mr. Mills determined it ….
All in, I don’t think Mr. Mills has a lot to complain about in getting hit with the penalty.
Did The Mills Really Lose ?
The case concerns the 2007 tax year. Apparently the Mills got away with over $2,000,000 in deductions for the first six years the scheme was in effect. The tax accounting issues raised by this are giving me a little bit of a headache. The $2,000,000 in allowed deductions reduced their basis in their LLC interests. Whether that will ever cost them anything depends on what else was inside the LLCs and how long they keep them running. How to sort that out would be a good question to ask on a partnership taxation exam.
You can follow on twitter @peterreillycpa.
Originally published on Forbes.com Jan 13th, 2013