The Internal Revenue Service (IRS) seems to be using new tools to audit interesting situations whereby a taxpayer achieves a substantial tax credit.
A tax credit can be so much more valuable than a tax deduction, as a deduction reduces income and then a tax rate is applied. Therefore, the marginal savings a deduction provides is only a portion of the amount incurred. Where a tax credit can offer a benefit up to 100% of the value of the amount spent. That benefit seems to have received focus by the IRS as we see a couple of recent tax court decisions seemingly to have discovered situations which were costing the Government money without providing the intended benefits to the economy.
In TC Summ. Op. 2016-81 (Berry) the taxpayer claimed $5,800 of self-employment income from the one-time sale of tools and machinery, self-employment income is reserved for those in their own recurring business intended to make a profit. By reporting this capital gain income as another type of income, Berry, then, “conveniently” qualified for a nice earned income credit. The court moved the income to Line 21 of Form 1040 (capital gains), removed the self-employment tax (and earned income credit) rightly stating that a one-time sale of tools is not considered an activity entered into for profit “with continuity and regularity.”
In the Federal Court of Claims case Foxx v. U.S., 2017 PTC 46 (Fed. Cl. 2017) a $2,500 preparer penalty was assessed because the preparer artificially reported additional income in order to claim a larger earned income credit for a client.
Rightly, there are limits to what can be accomplished with tax planning.
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