Tax Amnesty Filing Costly Move for Iowa Taxpayer
On December 5, 2018, the Iowa Court of Appeals considered a taxpayer's challenge to the Tax Amnesty Act of 2007. The Court of Appeals found that because plaintiff failed to file a 2002 tax return, amnesty was waived and the Department of Revenue could disallow deductions for the following four years.
Tax Amnesty Act of 2007
The Tax Amnesty Act of 2007 was created to encourage both individuals and businesses to resolve past tax liabilities during September 4th through October 31st, 2007. Parties who rectified issues during this time would not be prosecuted. Additionally, the Department of Revenue (the Department) agreed to waive all penalties and half the interest normally associated with delinquent payments.
Several states have implemented tax amnesty programs in order to quickly raise short-term revenue. Taxpayers are “given a chance to wipe their slate clean” if all required returns were filed. Failure to pay all tax liabilities due as of December 31, 2006, would invalidate the amnesty.
The plaintiff is an Iowa native who returned the state in 1990 after serving in the United States Navy and working for the railway industry. Before his retirement, his work took him all over the county. He owned two condos, one in Georgia and one in Virginia.
The plaintiff originally moved to Marion, Iowa, to live with his sister and brother-in-law. When plaintiff’s brother died in 2003, he began to manage the family farm. Additionally, the plaintiff continued railway consulting throughout his retirement and leased his condos after the move to Iowa.
On October 31, 2007, the plaintiff filed for tax amnesty. On his application, he marked “Return has not yet been filed” and attached his 2006 return. The plaintiff sent the amount owed ($293 in taxes and $6.15 for one-half of the interest) along with his returns from 2003, 2004, and 2005 and stated he owed no additional taxes for those years.
To complete the review, the Department needed information regarding the plaintiff’s failure to file a 2002 return. While waiting for this information, the Department found a pattern of “substantial losses and little or no income being reported on them.” The plaintiff had reported losses for his railway consulting business, condominium rentals, and farming operation.
The Department denied the plaintiff’s amnesty request because of his failure to file a 2002 Iowa individual income tax return. Additionally, the Department rejected the claimed business losses for 2003-2006. This resulted in an additional penalty, tax, and interest in the amount of $13,182.98.
The plaintiff protested the Department’s finding with an Administrative Law Judge (ALJ), and the ALJ affirmed. The plaintiff appealed to the district court, which also affirmed. The plaintiff then appealed to the Court of Appeals.
Denial of Amnesty
Under the Tax Amnesty Act of 2007, a taxpayer could pay previous tax liabilities without penalty. However, the Act required all tax liabilities and one half of the interest to be paid in order to qualify for amnesty. Here, the Department denied amnesty because there was no record of a tax return for 2002.
The plaintiff claimed he filed a 2002 return, but he was unable to produce the return. The plaintiff claimed proof of the return was lost in a farm burglary. He also claimed the Internal Revenue Service’s own publications only required retention of returns for three years. All these circumstances, he claimed, showed a “good cause” for not filing a 2002 return.
The Court of Appeals affirmed the ALJ’s finding that the plaintiff did not file a 2002 tax return. The court noted the plaintiff could not produce the record and neither the Department nor the IRS had any record of a 2002 return. Additionally, no part of the Act allowed “good cause” for not filing a state tax return.
The plaintiff also argued the Act only required a taxpayer to file an application, pay taxes that are due, and file the required returns. He claimed the Act did not specifically state that unfiled tax returns would result in a denial of amnesty. However, the Act states “[f]ailure to pay all tax liabilities due the state and delinquent as of December 31, 2006 shall invalidate the amnesty.” Because the plaintiff failed to pay the 2002 tax liabilities, amnesty was denied.
Business Losses Denied
After looking through the plaintiff’s tax returns from 2003-2006, the Department found a history of losses with very little reported income. The plaintiff attempted to deduct business losses for his railway consulting business, his condominium rentals, and his farming operation for that time period.
Iowa law allows taxpayers to deduct ordinary and necessary business expenses. Taxpayers may deduct business expenses when they engage in activity for profit. Taxpayers need not have a reasonable expectation of profit, but they must have a good faith intent to make a profit. To determine if there is profit motive, the court will use nine factors. These include: “(1) how the taxpayer carries on the activity; (2) the taxpayer’s expertise; (3) time and effort expended by the taxpayer in carrying on the activity; (4) the expectation assets used in the activity may appreciate in value; (5) the success of the taxpayer in conducting similar or dissimilar activities; (6) history of taxpayer income and losses from the activity; (7) the amount of occasional profits earned, if any; (8) the taxpayer’s financial status; and (9) personal pleasure or recreation derived from the activity.”
The court found the plaintiff did not have sincere profit motive in any of the three claimed businesses. In regard to the railway consulting business, the court went through each of the nine factors and found the way the plaintiff managed his business suggested he did not have a true profit motive. He did little to reduce overhead and did not adapt to market demands. He had no background running a consulting business and only worked 300 hours in 2004. Additionally, the plaintiff incurred many losses but never had a profit. While it is difficult to determine the amount of personal pleasure derived from an activity, the ALJ “believed [plaintiff] likely enjoyed attending conventions and maintaining contact with others in the rail industry.”
When considering the business losses for the condominium rentals, the court found no true profit motive behind the business. The plaintiff owned two condos during the tax years at issue. The Virginia condo, according to plaintiff, served as headquarters for his railway consulting business. The plaintiff reported costs such as mortgage interest, property insurance, depreciation, and furniture storage. However, after evaluating the nine factors of profit motive, the court found there was even less true profit motive with the condos than for the consulting business. The plaintiff did little to market the condos and neither location was leased during the tax years at issue. He had no experience in rentals and did not seek professional help. The plaintiff made quarterly trips to the property but never stayed more than a few days. These facts were taken into consideration when determining whether the plaintiff had true profit motive.
Finally, the Court of Appeals affirmed the Department’s decision to disallow claimed losses for the farming operation. The plaintiff took over his brother’s farm as farm manager in 2003 following his brother’s death. While the plaintiff treated the farm as his own, the brother’s estate did not close until 2008. The plaintiff reported personal expenses totaling $92,836.84 for tax years 2003-2006 and a total farm rental income for that same time period of $17,340—a total loss of $75,496.84. While the ALJ disagreed with the Department regarding the net losses for tillable land, she found the plaintiff was unable to explain how many of his expenses related to the farming operation (expenses for travel to the farm, expenses for rental vehicles and equipment, repairs, storage, and utilities).
On appeal, the plaintiff claimed his procedural due process rights were violated because the ALJ allowed the Department to pursue a new claim regarding the “excessive” amount of expenses claimed. The court found plaintiff had ample notice that the Department questioned his deductibility of farm expenses. During the administrative hearing, the plaintiff answered questions regarding multiple trips per week to his brother’s farm. Plaintiff made two to three trips every week from his home in Marion to the farm in Howard County (240 miles round trip). The question and answer at the administrative hearing provided plaintiff with notice and time to respond to the claim.
The Center for Agricultural Law and Taxation does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. The Center's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.