Clarifying the substantial underpayment 20% hammer, Judge Ruwe delves into Section 6664, and answers more questions than anybody really had, in Glenn Lee Snow, 141 T. C. 6, filed 9/19/13.

Blogging Tax Court is a real tour d’horizon; every day brings a different view. Yesterday it was a $13 million deficiency for BMC Software, Inc., which got a lot of chatter in the financial press. Apparently the reporters thought it was a transfer pricing case, which is the big buzz nowadays. It was, but only tangentially. You can get the real story here. See my blogpost “Stipulate, Don’t Capitulate – Redivivus”, 9/19/13.

But today we’re back in the world of the in-the-trenches preparer, as Glenn Lee is fighting about the $5567 he overstated as his withholding (he treated his FICA and Medicare/Medicaid as withheld, rather than as taxes he owed and paid). This triggers the $3K substantial understatement penalty that is at issue here.

Had he not played the clown, Glenn’s withholding of $11K was close enough for jazz (Glenn Lee is a musician), as his tax bill was under $13K. But Glenn Lee got hit with an $8K Section 6673 frivolity (that he doesn’t contest), and he agrees with the $13K tax.

I didn’t drop a blogpost when Glenn Lee got nailed by Judge Ruwe back on 4/22/13, in 2013 T. C. Memo. 114. It was a run-of-the-mill protester case, so Judge Ruwe sent IRS and Glenn Lee off for a Rule 155.

And that’s when the fight started.

IRS wants to treat the $5567 overstated withholding, for which Glenn Lee got a refund, as part of a substantial underpayment, as Glenn Lee got the $11K in withholding refunded to him too. So Glenn Lee’s understatement of tax was north of $18K, per IRS’ arithmetic.

Glenn says no, it was the $13K I should have paid, but didn’t.

The magic language is Section 6664(a), which defines “underpayment” as the amount shown on the return the taxpayer filed, plus “amounts not so shown previously assessed (or collected without assessment)”, over the amount of rebates made. Rebates means “so much of an abatement, credit, refund, or other repayment, as was made on the ground that tax imposed was less” than the excess of the amount shown on the return plus the amounts not shown but previously assessed or collected without assessment.

Clear? Thought not.

The idea is that overstated withholding equals underpayment of tax, and Judge Ruwe has caselaw that says so, upholding Reg. 1.6664-2(c)(1), which also says so.

Glenn Lee claimed his tax due was zero, hence the Section 6673 $8K dopeslap.

Glenn Lee did have $11K withheld, and Judge Ruwe says that might be “collected without assessment”, but “…petitioner received a refund of $16,684.65. Section 1.6664-2(d), Income Tax Regs., provides that the excess of credits allowable over the tax shown on the return is an amount ‘collected without assessment’ if the excess has not been refunded to the taxpayer. The excess of the amount of credits allowable under section 31 ($11,117.65) over the tax shown on the return (negative $5,567) was refunded to petitioner ($11,117.65 + $5,567 = $16,684.65), therefore, petitioner had $0 of collections without assessment. Therefore, under section 1.6664-2(a)(1)(ii), Income Tax Regs., petitioner had $0 amounts collected without assessment.” 141 T. C. 6, at pp. 10-11. (Footnotes omitted, but Judge Ruwe goes through the Regs in great detail).

Judge Ruwe has another problem: “Section 1.6664-2(e)(2), Income Tax Regs., requires us to determine ‘rebates previously made’. The regulation does not define rebates previously made. The regulation provides that rebates previously made is a component of calculating rebates. The use of the phrase ‘previously made’ implies that there is a point in time in which a ‘rebate’ must be determined to have been made so that ‘rebates previously made’ were made prior to the ‘rebate’. The regulation does not explicitly state the point in time.

“The logical cutoff point in time to determine a ‘rebate’ would be at the time the return that claims a refund is filed. Therefore, we would interpret ‘rebates previously made’ to mean rebates made before the return was filed.” 141 T. C. 6, at p. 14.

Ditto as to rebates.

“No rebates were made to petitioner before he filed his return.” 141 T. C. 6, at p. 14-15.

So the final number is that Glenn Lee understated his tax by including the overstated withholding. There were no “rebates previously made”,  and no “rebates”, because Glenn Lee took back all his withholding, tax, FICA and Medicare/Medicaid.

Judge Ruwe says this “produces a result that bases the section 6662 penalty on an ‘underpayment’ amount that represents the amount of revenue that the Government was deprived of as a result of amounts actually shown on petitioner’s return.” 141 T. C. 6, at p. 16.

IRS wins. Glenn Lee, see my blogpost “Pay The Man”, 7/31/12; ya shoulda paid the man.