In PLR 201219005, the Internal Revenue Service (the Service) granted an extension to allow taxpayers who treat investment income as capital gains to correct a mistake made by their tax preparer.
FACTS / LAW
Tax Advisor assumed based on previous dealings with Taxpayers, that proceeds from a loan secured by securities were used to purchase the securities. Tax Advisor therefore deducted the loan interest as investment interest on Taxpayers’ return.
The Service examined the return, questioned the deduction, and Advisor admitted to mistakenly taking the deduction after consulting with Taxpayers.
Taxpayers then sought permission by requesting this revenue ruling to treat the investment income as capital gains.
A non-corporate taxpayer cannot deduct investment interest in excess investment income. 163(d)(1). Investment income can include capital gain if the investor elects to. 163(d)(4)(B)(ii). The election must be filed before the return is due and is revocable with the consent of the Commissioner. 1.163(d)-1(b), 1.163(d)-1(c).
The Service analogized the election other regulatory elections. Applications for relief will be grated when: (1) the taxpayer acted reasonably and in good faith, and (2) granting relief would not prejudice the interests of the Government. PLR 201219005 (Citing 301.9100-1(e)(2)).
A taxpayer is deemed to meet the first requirement if the taxpayer reasonably relied on a tax professional. 301.9100-3(b)(1)(v). However, a taxpayer does not act reasonably and in good faith if taxpayer: (a) seeks to alter a return position to avoid an accuracy related penalty; (b) was fully informed of, but choose not to take the election previously; (c) uses hindsight in requesting relief. PLR 201219005 (Citing 301.9100-3(b)(3)).
Regarding the second requirement, the interests of the government are prejudiced if granting relief would result in lower tax liability than if the election had been timely made. 301.9100(c)(1).
ISSUE / RULING
(1) Whether Taxpayer acted in good faith.
(2) Whether the government will be prejudiced.
The Service determined Taxpayers acted in good faith since they relied on Tax Advisor. Moreover, the Service determined the government was not prejudiced because Taxpayers would not have had lower overall tax liability if they had made the election at the appropriate time. The Service therefore granted Taxpayers relief, allowing them 60 days to make the election.
We believe the Service comes to the correct conclusion. Traditionally, the Service has allowed taxpayers some deference when they reasonably rely on a tax preparer. Here Tax Advisor erred in making an assumption and taking the investment interest deduction. Had Tax Advisor not erred, the return presumably would have been filed with the election. The Service is simply allowing Taxpayers to fully correct their previous mistake.
I hope this helps you help others.
Robert S. Keebler, CPA, MST, AEP
Cites: PLR 201219005 (05/11/2012)