IRS and State Tax Controversy
Tax controversies occur principally at the audit, IRS appeal and tax court levels. It is important when contesting a tax issue to have a command of the facts involved. Also significant is a through knowledge of the law involved, as well as the procedures of the forum and the authority and responsibility of the person representing the IRS. An experienced tax practitioner would surreptitiously let the IRS Agent or IRS Appeals Officer know that he knows what responsibilities the Agent or Officer owes to the taxpayer.
The presentation of tax data and documentation is certainly important at any level. But it is equally important to know how to supplement the weaknesses of your position with legal precedents. For example, a significant expense, say cash payments to laborers, may have been disallowed at the audit level because payments were made with cash, not checks, and Form 1099s were not issued to the workers or the IRS. Because checks were not used to pay the workers there is a proof problem. Knowing that at the appeals or tax court level testimony of the taxpayer would be permitted to supplement the evidence is crucial to winning the issue at IRS Appeals or Tax Court. Also, scratch pad notes containing the dates, names of the workers and amounts of cash paid to them would be proper evidence. At the audit level these notes most like would not be allowed, and if you cannot prove your case with absolute certainty the deduction will not be allowed, however, there are court cases that indicate that what happened at the audit level is not the final conclusion. Knowing what these cases say is imperative in a tax controversy. Thomas F. DiLullo has represented taxpayers in nearly a thousand contested tax controversies over the years, and he is happy to assist taxpayers with these matters.
New Jersey sale tax audits of cash business are of particular interest. The State auditors frequently reconstruct the business's annual sales using statistical methods, which are then applied to the past four years sales tax returns. The sales tax due as a result of such an audit is usually very substantial because of the statistical methods employed. The leading cases are summarized below:
Yilmaz v. Director, Division of Taxation, 22 N.J.Tax 204, N.J.Tax, Apr 01, 2005 (NO. 000240-2003).
The principal issue in Yilmaz is the validity of the “markup” analysis performed by the Director’s auditor in reconstructing plaintiff’s income and receipts.
The Tax Court concluded:
That, in a case involving a challenge to a determination by the Director based on an audit of a cash business, involving only factual issues and the methods employed by the Director, the standard set forth in Pantasote Co., supra, 100 N.J. at 413, is a reasonable and practical one. That is, the presumption that the Director’s assessment is correct can be rebutted only by cogent evidence that must be “definite, positive and certain in quality and quantity to overcome the presumption.” Ibid. That evidence must focus on the reasonableness of the underlying data used by the Director and the reasonableness of the methodology used. Ocean Pines Ltd., supra, 112 N.J. at 11. An “aberrant” methodology will overcome the presumption of correctness. Id. at 12. An imperfect methodology will not.
Yilmaz v. Director, Division of Taxation, 390 N.J.Super. 435, 915 A.2d 1069 (N.J.Super.A.D., 2007).
On Appeal, the Appellate Division affirm substantially for the reasons articulated in the Tax Court decision. However, the Appellate Court added:
There is nothing to prevent a taxpayer from producing competent independent evidence, expert or otherwise, to challenge that presented by the Director and demonstrate that the Director's methodology was aberrant or the amount of the assessment was far wide of the mark. Moreover, a taxpayer can produce evidence through cross-examination of the auditor that is sufficient to overcome the presumed correctness of the Director's assessment and to establish that the sales tax assessment should be reduced. Charley O's, Inc., t/a Scotty's Steakhouse v. Director, Division of Taxation, 23 N.J. Tax 171, 172 (Tax 2006).
Charley O's, Inc., t/a Scotty's Steakhouse v. Director, Division of Taxation, 23 N.J. Tax 171 (Tax 2006).
The Tax Court found the Director's methodology to be "aberrant and not merely imperfect."
The Tax Court recognizing the Director had the authority to use the markup method found he did not have the authority to adopt the gross receipts reported on the taxpayer's CBT returns over the gross receipts reported on the sales tax returns "merely because it was more convenient to do so or because the use of the gross receipts reported on the CBT return produced a larger sales tax liability." Additionally, and most critical to the court's determination, was that the auditor was directed to stop his markup analysis before it was complete and to arbitrarily increase the taxpayer's purchases which, when multiplied by the markup ratio, would equal the gross receipts reported on the CBT returns.