I’ve commented before about the preparation software trap. See my blogposts “Real Estate Professional Revisited”, 3/24/11, and “Basis for Dummies”, 11/24/11, in the latter post specifically my discussion of Kurt C. Olsen, T. C. Sum. Op. 2011-131.

Now the shrink-wrap gurus may not claim to be foolproof guides, philosophers and friends, taking the innocent and inexperienced through the impenetrable thicket, unintelligible alike to laypeople and lawyers, that is the Internal Revenue Code, and its pendant Regulations, Revenue Rulings, Revenue Procedures and Notices. And I’m sure the software developers’ counsel have festooned box and contents with disclaimers and exculpatory exhortations worthy of the medieval indulgence mongers.

But I’d argue that the prevalence of the software, the public’s apparently inexhaustible appetite for same, and IRS’ increasing, and well-publicized, reliance thereon for e-filing and free-filing, causes taxpayers to think that the digital wizard behind the cellophane will solve all their problems. And, incidentally, computers give Congress the impetus to complicate the IRC even further, as no taxpayer needs to understand what they’ve done, because Doug Shulman’s guys and the geeks at TurboTax and others of that ilk will solve it all.

Of course, reliance on the CD-ROM enshrined in the fetching cardboard box, which promises fast fast fast relief from the annual income tax headache, and frees one from entanglement with paid preparers now registered and charging appropriately, avails the taxpayer naught when enmeshed like Laocoön in the aforesaid thicket.

Today’s post-Labor Day blues is brought to you by Judge Cohen, as she unpacks the sad tale of Brenda Frances Bartlett, T. C. Memo., 2012-254, filed 9/4/12.

Brenda Frances retired from Qwest Communications at the youthful age of 50. As she strode for the last time from her cubicle, she was handed the $221K accumulated in her pension account.

Brenda Frances reported only half that amount on her 1040, and failed to report $2K in other income and a couple of hundred bucks in wages.

When IRS nailed Brenda Frances for $44K in unpaid tax, plus penalties (10% Section 72(t) early withdrawal plus Section 6662(d) accuracy for over $5K or 10% understatement of tax due), she blamed TurboTax, with which she claimed she was unfamiliar.

Brenda Frances admitted she understated her tax.

No go, says hard-hearted Judge Cohen. Brenda Frances typed in the wrong information. “It is apparent that a portion of the information petitioner entered into the TurboTax program was incorrect; hence the mistakes made (which resulted in the underpayment) were made by petitioner, not TurboTax. TurboTax is only as good as the information entered into its software program. See Bunney v.Commissioner, 114 T.C. 259, 267 (2000). Simply put: garbage in, garbage out.

“Petitioner’s errors were not merely isolated computational or transcription errors. See sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner systematically underreported her income and this resulted in an underpayment of tax on her Federal tax return. Petitioner did not have reasonable cause for any portion of the resulting underpayment. Respondent’s determinations as to both the tax deficiency and penalty are sustained.” T. C. Memo. 2012-254, at pp. 4-5.

So if, like Kurt, you put one item on the wrong line, you might get away without penalties, but Brenda Frances went a little too far.

Maybe the shrink-wrapped gurus might carry a warning: RELYING ON THIS SOFTWARE COULD BE HAZARDOUS TO YOUR TAX HEALTH.

Maybe not, if your partner really isn’t your partner. See Historic Boardwalk Hall, LLC, et. al. v. Com’r., Docket No. 11-1832, 3d Cir., 8/27/12, a little Labor Day light reading overturning Tax Court’s decision released 1/3/11, 136 T. C. 1. See my blogpost “Social Engineering Trumps the Code”, 1/3/11.

This case arose from a Section 47 Historic Rehabilitation Tax Credit (HRTC). The New Jersey Sports and Exhibition Authority (not to be confused with a sneaker retailer of similar name) wanted to make the old Atlantic City landmark into a sports and exhibition venue, but needed to raise money. So Pitney Bowes, the postage meter company, came into the deal through a broker who was selling tax credits.

You’ll remember Tax Court said, essentially, that to disregard the effects of the tax credits would be to disregard Congress’ will–to encourage the rehabilitation of historic structures and that Congress knew that the majority of such rehabilitation projects could not succeed without tax incentives. So the Tax Court ran roughshod over any conflicting provision of Code or Regulations that IRS could muster.

Third Circuit wasn’t having any of this. Although paying lip service to Tax Court’s notion that “…the HRTC statute is a deliberate decision to skew the neutrality of the tax system to encourage taxable entities to invest, both in form and substance, in historic rehabilitation projects,” (Decision at p. 15), Third Circuit reverses Tax Court and torpedoes Pitney’s credit.

While the rehab project was supposedly a partnership between New Jersey Sports and Pitney, Pitney had virtually zero economic risk; no real share in profits and losses; and could be taken out with its tax credit intact. And New Jersey Sports guaranteed Pitney against any tax loss.

Now economic substance was argued, but did not play a role in the outcome. “Accordingly, we focus our analysis on whether PB is as a bona fide partner in HBH [Historic Boardwalk Hall, the partnership], and in doing so, we assume, without deciding, that this transaction had economic substance. Specifically, we do not opine on the parties’ dispute as to whether, under Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995), we can consider the HRTCs in evaluating whether a transaction has economic substance.” Decision, at p. 54, continuation of footnote 50.

So the issue is whether Pitney had any interest in the success or failure of HBH as an ongoing enterprise. If not, there was simply a prohibited sale of a tax credit. In short, did Pitney have any skin in the game?

Now there’s a lengthy discussion of the difference between economic substance and form-over-substance, and the famous codification of economic substance in the 2010 Health Care Act, but here none of this is relevant. Likewise there’s no suggestion that partners cannot limit their risk in an enterprise. But here Pitney had no meaningful risk to the downside, and no realistic prospect of gain to the upside, barring the HRTC.

So, as I said in my blogpost “Social Engineering Trumps the Code”, 1/3/11, “(T)he Third Circuit will no doubt have something to say about this. Follow.”

Did they ever!