The Corrected IRS Tax Audit Results: Eating Crow
Eating crow is not an appetizing event but a necessary one on this occasion. In his article published here and originating on another blog, Board Treasurer Dan Forgeron writing “as an informed resident” but with firsthand knowledge of the events states that I was wrong about what had happened in his December 14th meeting with the IRS auditor as well as about certain tax conclusions I made pertaining to the association’s potential tax liability. Indeed, Dan is correct.
Frankly, it was refreshing to see that Mr. Forgeron was willing to open the door on these tax-related matters that President Jack Troia could have addressed in his board statements had he wished to be more forthcoming. Had Jack been more helpful along the way in providing additional information, such efforts might have prevented some of the ensuing speculation and misstatements. Dan Forgeron should be commended for shedding more light on these matters.
Since the IRS audit had been concluded in December, I incorrectly assumed that the auditor had discussed the results of the audit at their mid-December meeting. While it seemed reasonable to me that such a discussion had taken place at that time, Dan says that no such discussion took place and that the meeting was confined to different tax issues. Dan's clarification was helpful.
It now appears that the IRS auditor never had an opportunity to have that final conference at any time. However, according to Jack Troia, we do know that such a conference had been scheduled in early January, but that meeting did not take place. Jack explained that that meeting was “not practical” for members of the board to meet, whatever "not practical" means.
It would be easy to jump to the conclusion that a decision was made by the board not to meet with the IRS in order to put off receiving any information about the audit’s results in advance of the upcoming January board meeting. Given Jack’s expressed disposition that the association had no tax problems, one might think that Jack would have been anxious to learn that fact so that he could share the good news at the board meeting. With no final conference on the auditor's results, there was nothing to report until much later after a presumably requested written report had been prepared and received in February.
On a more major topic of considerable embarrassment, I had projected a potential tax liability of up to 5 million dollars. I was wrong. Dan correctly pointed out that in the event the association agreed with the IRS auditor’s proposed changes to the 2007 tax return, that decision would increase the association’s taxable income by roughly $3+ million. As a result, that amount would not be available as excess income to carryforward to 2008 and 2009. Accordingly, the carryforward amounts that were reported on the 2008 and 2009 tax returns should be reduced by that $3+ million amount. In neglecting to account for those reductions in the years following 2007, I erroneously calculated a potential tax liability that was not owed.
However, subsequent carryforward amounts in 2008 and 2009 that were in excess of that 2007 amount, totaling $2.3 million for the 2008-09 period, might be taxable or non-taxable income depending on whether or not those excess income amounts qualify for exclusion under IRS Revenue Ruling 70-604. If excess income amounts do qualify, there would be no additional tax liability due.
According to Dan Forgeron, “the IRS is simply disallowing a deduction claimed as a result of the valid 70-604 election. As a result of their disallowance, they have included a [20%] penalty in the amount of $224,133 under Internal Revenue Code Section 6662(d).” Relying on that penalty figure and the amounts reported on the 2007 tax return, I have prepared a corrected Form 4549 that hopefully is more accurate than the one I had initially prepared. Admittedly, the complexities of the association’s tax return and numerous tax form schedules are beyond my comprehension.
Mr. Forgeron writes of his opinion that he believes the association has strong valid objections to the proposed IRS adjustments. That would suggest that the board will respond to the IRS stating that they do not agree to the proposed adjustments, thereby initiating steps in the appeal process. Perhaps at the upcoming board meeting we, along with the remaining board members, will learn more about those strong and valid objections as well as how an appeal might affect the outcome in the event the board and the IRS are unable to resolve their differences.
In such contested matters there are two issues. The first is how the IRS revenue ruling applies to the 2007 tax return in the case of a valid 70-604 election, and second, whether there any unusual circumstances or valid objections that would permit a reduction in the amount owed. Mr. Forgeron appears to believe that the association has a leg up in challenging the proposed tax adjustments due to the IRS’s agreement that the association had made a valid election to adopt RR 70-604. While the association’s election to adopt 70-604 may have been permitted under Nevada statutes, that election decision says nothing about whether the association complied with the ruling’s provisions to:
As homeowners already know, niether (1) or (2) happened. It’s reasonable to conclude that the association's failure to do either (1) or (2) triggered the IRS’s decision to disallow the claimed deduction and treat such amounts as association income, that is, as taxable income. In doing so, the IRS calculated $1,345,000 or thereabouts as the amount owed. My guesstimate of the breakdown of that amount is shown below.
| 1 | Taxes owed | $1,080,917 |
|---|---|---|
| 2 | Interest | $39,748 |
| 3 | Penalty | $224,133 |
The tax is based on applicable tax rate of 34%. When that rate is applied to the 2006 carryforward amount of $3,179,168 reported on the 2007 tax return, the amount of taxes owed is $1,080,917. The 20% penalty allied to the taxes plus interest, equals $224,133. As shown on my sample Form 4549, the total amount owned equals $1,344,798.
Ron Johnson, 22 February 2011