How much reliance can you place in tax software marketed to consumers? What are some red flags that you might need to seek specialized advice?
A cautionary tale comes from a recent Tax Court case. In the case, the taxpayer made mistakes in claiming deductions for alimony and business-related expenses including interest payments. His excuse: software “lured” me into claiming the deductions.
Divorce, spousal support & shoddy record keeping
The first issue, a divorce order requiring spousal support to an ex-wife of $2,000 per month. These payments were to increase to $8,000 with the sale of their marital home. The housing market was slow at the time and the house languished. The taxpayer and his ex- reached an oral agreement to modify payments to $5,000 per month.
For alimony/spousal support to be deductible, however, the payment must be ordered in a divorce or separation agreement. An oral modification will not satisfy the tax code. Thus amounts above the court-ordered $2,000 were not deductible. Some sound legal advice around the time that the modification was made might have been able to avoid this problem.
The second issue was record keeping. The taxpayer didn’t have the records to support his deductions of business expenses and business loan repayments.
Deductions denied, penalties assessed
Once the Tax Court denied the deductions, back taxes, interest and penalties were assessed.
In trying to avoid the accuracy-related penalty, the taxpayer again made an argument along the lines of the “software made me do it.” Because the understatement equaled more than $5,000 and 10 percent of the tax, it was substantial. Then the court reasoned, “Tax preparation software is only as good as the information one inputs into it.”
This taxpayer was actually an insurance consultant serving accountant clients. Rather than seek help from one of these clients, he chose the DIY route.
The tax code is complex and often doesn’t allow for creativity or expansive readings. When questions come up about whether a deduction is allowed or later in dealing with an audit, seek advice from a tax attorney.