Business Law Question

August 15th, 2021Internal Revenue Service
(address from the form)
Re:
Robert Richards
SSN: 333-44-4444
RE: Appeal of Proposed Tax Assessment for Tax Year 2019
Dear Officer,
We have received your letter dated August 15, 2021 along with Form 4549-E (Income Tax
Discrepancy Adjustments) proposing adjustments to Mr. Robert Richards’ tax return for the tax
year 2019. We formally appeal the proposed modifications to Mr. Robert Richards’ tax return for
the tax year 2019, specifically the disallowance of the business bad debt deduction claimed for a
debt owed by Robert’s Rulers, Inc. (RRI), Mr. Richards’ fully owned S corporation. This appeal
is filed according to rights outlined in IRS Publication 5 (Rev. 04/21).
Appeal Protest Letter
Robert Richards, the taxpayer, is protesting the changes in tax liability detailed in the IRS Notice
at this time. In support of this protest, the following information is provided by our appeal rights
as stated in IRS Publication 5 (Rev. 04/21).
1. Conference Request: We request an in-person conference relating to this appeal, as
permitted by IRS Publication 5 (Rev. 04/21).
2. Taxpayer Information:
o
Name and Address: Robert Richards, 1234 West 80th St, Miami, FL 33131
o
SSN: 333-44-4444
o
Phone Number: 305-001-0304
3. Tax Protested:
o
Date of IRS Notice: August 15, 2021
o
Form Assessed: 1040
o
Disallowed Deduction: Business Bad Debt for RRI
4. Periods: Tax Year 2019
5. Basis for Appeal: The determination appealed from is based on the following error:
o
The IRS incorrectly disallowed the business bad debt deduction for Mr. Richards’
payment of RRI’s debt to Inch by Inch, Inc. (IBI).
6. Facts in Support:
a. Mr. Richards is an employee of RRI, Mr. Richards’ primary source of income is his
salary and corporation distributions (Internal Revenue Code § 1361(a)(1)).
b. RRI faced serious cash flow problems and missed on payments to IBI, a critical supplier.
c. IBI threatened to cease supplying essential components to RRI and potentially force RRI
into bankruptcy if outstanding invoices remained unpaid. This would have jeopardized
Mr. Richards’ employment, business reputation, and potentially RRI’s existence.
d. Mr. Richards has paid the company’s outstanding debt to IBI to prevent this outcome.
The company went out of business later that year.
e. Mr. Richards claimed the personally paid debt to IBI as a business bad debt deduction on
his 2019 tax return Internal Revenue Code § 166(a)).
7. Legal Arguments:
The IRS disallowance of the business bad debt deduction for Mr. Richards’ payment of RRI’s
debt to IBI is incorrect. Mr. Richards’ actions meet the criteria for a valid business bad debt
deduction as outlined in the Internal Revenue Code and relevant case law:
a. Debt Originated in the Course of Business:
The debt originated from RRI’s business operations, a necessary expense to maintain a critical
supplier relationship with IBI (Section 1.166-1(a) of the Income Tax Regulations). This
regulation states: “A debt which has its origin in the taxpayer’s trade or business is one arising
from the direct operation of the trade or business.” Since RRI’s debt to IBI was for essential
components needed to run the business, it qualifies under this regulation.
b. Reasonable Expectation of Repayment:
While RRI ultimately failed, there was a reasonable expectation of repayment at the time Mr.
Richards personally settled the debt. Failure to address the debt with IBI would have resulted in
RRI’s immediate financial collapse (Section 1.166-1(b) of the Income Tax Regulations). This
regulation specifies, “The debt arose from a debtor-creditor relationship based on a genuine
expectation of repayment.” Given the critical nature of the supplier relationship and the potential
consequences of non-payment, a reasonable expectation of repayment existed.
c. Debt Became Worthless:
The circumstances surrounding the debt payment give cause to the request for an appeal. The
debt payment was made to prevent the company from filing bankruptcy proceedings and
preserve the client’s primary source of income. The tax code § 166(a)(1) of the IRC allows a
taxpayer to potentially claim a bona fide business debt as a deduction if the debt can be proven as
worthless during the tax year in which the deduction is claimed (Section 1.166-1(c) of the
Income Tax Regulations).
For tax purposes, a worthless business debt is determined by the ability of the officers of the
business to repay its debt. Factors that may contribute to the inability to repay consist of filing
for bankruptcy, signs of financial distress, or defaulting on debt or loan. Reg § 1.166-2 supports
the evidence mentioned for the definition of worthlessness.
The client’s effort to pay off the debt was stunted due to the distress of lack of cash flow. This
prevented the client from making payments to his biggest supplier, which threatened the client
with potential bankruptcy. Since RRI went out of business, the debt became uncollectible,
satisfying this regulation’s requirement.
d. Job Preservation:
Payment by Robert was an aspect of job preservation because the collapse of his company would
have meant the loss of jobs for Robert and other workers. We trust that the Appeals Division will
consider this and approve the business bad debt deduction as a valid expense for Robert’s
business. Some relevant case laws to defend our opinion are found below:
John A. Bianco, Jr., M.D., P.C. v. Commissioner (T.C. Memo. 1998-472): This case involved
an S corporation owner who personally guaranteed a loan to the corporation. When the
corporation defaulted, the owner made good on the guarantee. The court allowed the owner to
deduct the payment as a business bad debt because it protected his employment and the ongoing
business.
e. Additional Supporting Case Laws:
• Deputy v. DuPont (308 U.S. 488, 1940): This case, though not directly related to bad
debt deductions, established the principle that expenses incurred to maintain or protect
one’s income-producing capacity may be deductible. Mr. Richards’ actions to preserve his
job security through protecting RRI as a going concern fall under this principle.
• Welch v. Helvering, 3 USTC ¶ 1164 (1939): This case established the principle that a
taxpayer can deduct expenses incurred to protect their business reputation. While not
directly related to job security, it highlights the deductibility of expenses safeguarding
income-producing capacity.
f. Internal Revenue Service Revenue Rulings:
• Revenue Ruling 57-328 (1957-1 CB 114): This ruling allowed a corporate officer to
deduct legal expenses incurred in defending a lawsuit that threatened his job security. The
ruling highlights that expenses incurred to protect an employee’s status as a going
concern can be deductible business expenses.
Additional Considerations:
•
Commissioner v. Tellier (17 AFTR 2d 633) emphasizes deductions are a matter of
legislative grace, but it doesn’t negate the possibility of a business bad debt deduction in
specific circumstances like Mr. Richards’.
•
Putoma Corp., et al. v. Comm. (44 AFTR 2d 79-5576 focused on the taxpayer’s primary
motive being to protect their investment. In Mr. Richards’ case, the dominant motive was
a dual concern: protecting his job (investment in his career and reputation) and preserving
RRI as a going concern.
g. Defense for accuracy-related penalty:
The IRS can impose an accuracy-related penalty under, [26 USC §6662(a)] “on any part
of a tax underpayment shown on a return. This penalty is equal to 20% of the
underpayment”. The IRS agent applied tax code §6662(b)(2) to compute an accuracyrelated penalty for our client. However, if the IRS is incorrect in disallowing the business
bad debt deduction and instead treats the losses as capital lossed, then the computations
on Form 4549-E would be inacurrate, potentially reducing the taxable income and he
accuracy-related penalty.
We want to inform you that the IRS agent mistakenly imposed an accuracy-related
penalty under §6662(b)(2) based on disallowed bad debt expenses. We have cited several
regulations and case laws that show why a bad debt deduction is justified.
Even if the IRS ignores the regulations and case laws supporting our client’s deduction of
bad debt expenses, our client still has a reasonable cause defense against any accuracyrelated penalty assessment. Our client acted in good faith and with reasonable cause in
claiming the bad debt as an expense. This constitutes “an honest misunderstanding of fact
or law” as covered in tax code §1.6664-4(b).
According to Rev. Proc. 2019-42, 2019-49 IRB 1298, 12/02/2019, IRC Sec(s). 6662 is a
taxpayer indicates in writing on their Schedule C (Form 1040 or 1040SR) that a
deduction is for a bad debt, it’s considered “adequate disclosure for reducing any tax
understatement.” The IRS ruling 2019-42 states that “This revenue procedure applies to
income tax returns filed in 2019 using 2019 tax forms, and to any income tax return filed
in 2020 on 2019 tax forms for short taxable years beginning in 2020.”
Conclusion:
Mr. Richards’ actions were aimed at protecting his job and keeping RRI operational. Mr.
Richards’ actions to preserve his job and RRI as a viable business qualify for the business bad
debt deduction under the Internal Revenue Code (Sections 166(a) & 1.166-1(a) through (c) of the
Income Tax Regulations) and relevant case law (John A. Bianco, Jr., M.D., P.C. v.
Commissioner). We respectfully request that the IRS Appeals Office reconsider the proposed
adjustments and allow the business bad debt deduction for the debt paid to IBI. We are available
to provide any further documentation or clarification needed.
Sincerely,
___(“signature”)_______________
Tax Group 1
This protest was prepared by the undersigned. The undersigned does not know personally
whether the statements of fact contained in the protest [and any accompanying documents] are
true and correct.
___(“signature”)_______________
Robert Richards
Under penalties of perjury, I declare that I examined the facts stated in this protest, including any
accompanying documents, and, to the best of my knowledge and belief, they are true, correct,
and complete.
August 15th, 2021
Internal Revenue Service
(address from the form)
Re:
Robert Richards
SSN: 333-44-4444
RE: Appeal of Proposed Tax Assessment for Tax Year 2019
Dear Officer,
We have received your letter dated August 15, 2021 along with Form 4549-E (Income Tax
Discrepancy Adjustments) proposing adjustments to Mr. Robert Richards’ tax return for the tax
year 2019. We formally appeal the proposed modifications to Mr. Robert Richards’ tax return for
the tax year 2019, specifically the disallowance of the business bad debt deduction claimed for a
debt owed by Robert’s Rulers, Inc. (RRI), Mr. Richards’ fully owned S corporation. This appeal
is filed according to rights outlined in IRS Publication 5 (Rev. 04/21).
Appeal Protest Letter
Robert Richards, the taxpayer, is protesting the changes in tax liability detailed in the IRS Notice
at this time. In support of this protest, the following information is provided by our appeal rights
as stated in IRS Publication 5 (Rev. 04/21).
1. Conference Request: We request an in-person conference relating to this appeal, as
permitted by IRS Publication 5 (Rev. 04/21).
2. Taxpayer Information:
o
Name and Address: Robert Richards, 1234 West 80th St, Miami, FL 33131
o
SSN: 333-44-4444
o
Phone Number: 305-001-0304
3. Tax Protested:
o
Date of IRS Notice: August 15, 2021
o
Form Assessed: 1040
o
Disallowed Deduction: Business Bad Debt for RRI
4. Periods: Tax Year 2019
5. Basis for Appeal: The determination appealed from is based on the following error:
o
The IRS incorrectly disallowed the business bad debt deduction for Mr. Richards’
payment of RRI’s debt to Inch by Inch, Inc. (IBI).
6. Facts in Support:
a. Mr. Richards is an employee of RRI, Mr. Richards’ primary source of income is his
salary and corporation distributions (Internal Revenue Code § 1361(a)(1)).
b. RRI faced serious cash flow problems and missed on payments to IBI, a critical supplier.
c. IBI threatened to cease supplying essential components to RRI and potentially force RRI
into bankruptcy if outstanding invoices remained unpaid. This would have jeopardized
Mr. Richards’ employment, business reputation, and potentially RRI’s existence.
d. Mr. Richards has paid the company’s outstanding debt to IBI to prevent this outcome.
The company went out of business later that year.
e. Mr. Richards claimed the personally paid debt to IBI as a business bad debt deduction on
his 2019 tax return Internal Revenue Code § 166(a)).
7. Legal Arguments:
The IRS disallowance of the business bad debt deduction for Mr. Richards’ payment of RRI’s
debt to IBI is incorrect. Mr. Richards’ actions meet the criteria for a valid business bad debt
deduction as outlined in the Internal Revenue Code and relevant case law:
a. Debt Originated in the Course of Business:
The debt originated from RRI’s business operations, a necessary expense to maintain a critical
supplier relationship with IBI (Section 1.166-1(a) of the Income Tax Regulations). This
regulation states: “A debt which has its origin in the taxpayer’s trade or business is one arising
from the direct operation of the trade or business.” Since RRI’s debt to IBI was for essential
components needed to run the business, it qualifies under this regulation.
b. Reasonable Expectation of Repayment:
While RRI ultimately failed, there was a reasonable expectation of repayment at the time Mr.
Richards personally settled the debt. Failure to address the debt with IBI would have resulted in
RRI’s immediate financial collapse (Section 1.166-1(b) of the Income Tax Regulations). This
regulation specifies, “The debt arose from a debtor-creditor relationship based on a genuine
expectation of repayment.” Given the critical nature of the supplier relationship and the potential
consequences of non-payment, a reasonable expectation of repayment existed.
c. Debt Became Worthless:
The circumstances surrounding the debt payment give cause to the request for an appeal. The
debt payment was made to prevent the company from filing bankruptcy proceedings and
preserve the client’s primary source of income. The tax code § 166(a)(1) of the IRC allows a
taxpayer to potentially claim a bona fide business debt as a deduction if the debt can be proven as
worthless during the tax year in which the deduction is claimed (Section 1.166-1(c) of the
Income Tax Regulations).
For tax purposes, a worthless business debt is determined by the ability of the officers of the
business to repay its debt. Factors that may contribute to the inability to repay consist of filing
for bankruptcy, signs of financial distress, or defaulting on debt or loan. Reg § 1.166-2 supports
the evidence mentioned for the definition of worthlessness.
The client’s effort to pay off the debt was stunted due to the distress of lack of cash flow. This
prevented the client from making payments to his biggest supplier, which threatened the client
with potential bankruptcy. Since RRI went out of business, the debt became uncollectible,
satisfying this regulation’s requirement.
d. Job Preservation:
Payment by Robert was an aspect of job preservation because the collapse of his company would
have meant the loss of jobs for Robert and other workers. We trust that the Appeals Division will
consider this and approve the business bad debt deduction as a valid expense for Robert’s
business. Some relevant case laws to defend our opinion are found below:
John A. Bianco, Jr., M.D., P.C. v. Commissioner (T.C. Memo. 1998-472): This case involved
an S corporation owner who personally guaranteed a loan to the corporation. When the
corporation defaulted, the owner made good on the guarantee. The court allowed the owner to
deduct the payment as a business bad debt because it protected his employment and the ongoing
business.
e. Additional Supporting Case Laws:
• Deputy v. DuPont (308 U.S. 488, 1940): This case, though not directly related to bad
debt deductions, established the principle that expenses incurred to maintain or protect
one’s income-producing capacity may be deductible. Mr. Richards’ actions to preserve his
job security through protecting RRI as a going concern fall under this principle.
• Welch v. Helvering, 3 USTC ¶ 1164 (1939): This case established the principle that a
taxpayer can deduct expenses incurred to protect their business reputation. While not
directly related to job security, it highlights the deductibility of expenses safeguarding
income-producing capacity.
f. Internal Revenue Service Revenue Rulings:
• Revenue Ruling 57-328 (1957-1 CB 114): This ruling allowed a corporate officer to
deduct legal expenses incurred in defending a lawsuit that threatened his job security. The
ruling highlights that expenses incurred to protect an employee’s status as a going
concern can be deductible business expenses.
Additional Considerations:
•
Commissioner v. Tellier (17 AFTR 2d 633) emphasizes deductions are a matter of
legislative grace, but it doesn’t negate the possibility of a business bad debt deduction in
specific circumstances like Mr. Richards’.
•
Putoma Corp., et al. v. Comm. (44 AFTR 2d 79-5576 focused on the taxpayer’s primary
motive being to protect their investment. In Mr. Richards’ case, the dominant motive was
a dual concern: protecting his job (investment in his career and reputation) and preserving
RRI as a going concern.
g. Defense for accuracy-related penalty:
The IRS can impose an accuracy-related penalty under, [26 USC §6662(a)] “on any part
of a tax underpayment shown on a return. This penalty is equal to 20% of the
underpayment”. The IRS agent applied tax code §6662(b)(2) to compute an accuracyrelated penalty for our client. However, if the IRS is incorrect in disallowing the business
bad debt deduction and instead treats the losses as capital lossed, then the computations
on Form 4549-E would be inacurrate, potentially reducing the taxable income and he
accuracy-related penalty.
We want to inform you that the IRS agent mistakenly imposed an accuracy-related
penalty under §6662(b)(2) based on disallowed bad debt expenses. We have cited several
regulations and case laws that show why a bad debt deduction is justified.
Even if the IRS ignores the regulations and case laws supporting our client’s deduction of
bad debt expenses, our client still has a reasonable cause defense against any accuracyrelated penalty assessment. Our client acted in good faith and with reasonable cause in
claiming the bad debt as an expense. This constitutes “an honest misunderstanding of fact
or law” as covered in tax code §1.6664-4(b).
According to Rev. Proc. 2019-42, 2019-49 IRB 1298, 12/02/2019, IRC Sec(s). 6662 is a
taxpayer indicates in writing on their Schedule C (Form 1040 or 1040SR) that a
deduction is for a bad debt, it’s considered “adequate disclosure for reducing any tax
understatement.” The IRS ruling 2019-42 states that “This revenue procedure applies to
income tax returns filed in 2019 using 2019 tax forms, and to any income tax return filed
in 2020 on 2019 tax forms for short taxable years beginning in 2020.”
Conclusion:
Mr. Richards’ actions were aimed at protecting his job and keeping RRI operational. Mr.
Richards’ actions to preserve his job and RRI as a viable business qualify for the business bad
debt deduction under the Internal Revenue Code (Sections 166(a) & 1.166-1(a) through (c) of the
Income Tax Regulations) and relevant case law (John A. Bianco, Jr., M.D., P.C. v.
Commissioner). We respectfully request that the IRS Appeals Office reconsider the proposed
adjustments and allow the business bad debt deduction for the debt paid to IBI. We are available
to provide any further documentation or clarification needed.
Sincerely,
___(“signature”)_______________
Tax Group 1
This protest was prepared by the undersigned. The undersigned does not know personally
whether the statements of fact contained in the protest [and any accompanying documents] are
true and correct.
___(“signature”)_______________
Robert Richards
Under penalties of perjury, I declare that I examined the facts stated in this protest, including any
accompanying documents, and, to the best of my knowledge and belief, they are true, correct,
and complete.
Date: September 1st, 2021
Internal Revenue Service
Department of Treasury
RE: Robert Richards (SSN: 333-44-5555);
Robert’s Rulers, Inc. (EIN: 11-2225555)
Dear Agent Williams (Employee ID: 1234568),
This correspondence seeks to formally contest the examination results detailed in Letter
525, the 30-day general letter, dated August 15, 2021, received by Robert Richards (the
Taxpayer). Group 7 Firm, acting on behalf of the Taxpayer, hereby submits this protest letter,
dated September 1, 2021, to challenge the proposed adjustments and penalties to the Taxpayer’s
income tax liability and request a procedural appeal before the Internal Revenue Service’s
Appeals Division.
1. Conference
The Taxpayer requests a conference in person to appeal before the Appeals Division.
2. Taxpayer’s Name and Address
Robert Richards
1234 W. 80th Rd., Miami, FL, 33133
cc Group 7 Firm
11299 SW 8th St, Miami, FL 33199
3. Itemized Schedule of Unagreed Adjustments
With consideration to the Taxpayer’s rights to challenge the outcome of the IRS examination
and solicit an impartial reconsideration of his case, we submit the following unagreed
adjustments, for the period ending December 2019, as outlined in Form 4549-E, for
correction via the requested appeal:
Form 4549-E
Period End 201912
1. a. Business Bad Debt
243,950
4. Corrected Taxable Income
348,000
16. Balance Due or (Overpayment) (Line 14 adjusted
36,418
by Line 15) (Excluding interest and penalties)
17. a. 6662(b)(2) Substantial Understatement of Tax
7,284
19. c. Interest (IRC § 6601) – computed to 12/31/19
1,679
19. e. Amount due or refund
45,381
4. The conclusions of the examination process warrant the submission of additional factual and
legal materials for a comprehensive evaluation by the Appeals Division. Enclosed hereto are
supporting documents and legal references substantiating our stance.
5. Statement of Facts
The Taxpayer is an employee and the sole owner of Robert Rulers Inc. (the Company), an SCorporation. The Company represents the Taxpayer’s dominant source of income and
personal business reputation. Given his relation to the Company, the Taxpayer actively works
to ensure the operational viability of the Company. The Company was facing potential
bankruptcy amid growing debts payable to and threats of discontinued service from Inch by
Inch, Inc. (the Vendor), the Company’s main supplier of an irreplicable component. The
Vendor’s components were required by the Company to maintain operational viability. To
avoid an interruption of service from the Vendor, the Taxpayer made a payment to the
Vendor, thus making a necessary business expense required to carry on the trade of the
Company.
6. Statement of Law
a. Pototzky (8 Cl. Ct. 308): establishes that merely holding a corporate office or position
without exercising financial authority is insufficient to consider the taxpayer a
responsible person.
b. Bernardi v. U.S. (507 F.2d 682): indicates that an officer not charged with general control
over a corporation’s business affairs is not responsible for the payment of taxes under
IRC Sec. 6672(a).
c. Godfrey, Jr, v. U.S. (784 F.2d 1568): establishes that individuals who do not exercise
control over the allocation of corporate funds or the payment of payroll taxes are not
willfully failing to pay over the taxes.
d. Harrington (504 F.2d 1306): provides a precedent where the government imposed
liability based on an individual’s authority to pay trust fund taxes, which is distinguished
from the present case where authority was illusory due to lack of control.
e. IRC Section 6671(b): defines the term person for the Trust Fund Recovery Penalty,
including officers or employees of a corporation who are under a duty to perform acts
related to collecting, accounting for, and paying over income and FICA taxes withheld
f. Wilson v. U.S. (250 F.2d 312): sets the standard for determining whether an individual is
a responsible person for the Trust Fund Recovery Penalty, focusing on whether the
individual had the final word on what bills should or should not be paid, and when.
g. IRM Section 5.7.3.3.1.2: provides guidance on assessing the Trust Fund Recovery
Penalty, indicating that non-owner employees who act solely under the dominion and
control of others are generally not liable for the penalty.
7. Summary of Position
With consideration to the Statements of Fact and Law, we respectfully request the IRS to:
I.
Reject the proposed $243,950 Business Bad Debt adjustment to the Taxpayer’s
income for the period ending December 2019.
II.
Reverse the $7,284 Substantial Understatement of Tax penalty and the $1,679 of
interest that correspond to the adjustment to the Taxpayer’s income for the period
ending December 2019.
Thank you for your consideration of this matter, and we eagerly anticipate further
instructions. We remain at your disposal to provide further clarification if needed. We have
prepared this protest on behalf of the Taxpayer, but we do not personally know if the statements
of fact contained and the supporting documents enclosed in this protest are true and correct.
Sincerely,
Group 7 Firm
Group Members: Gabriel Fernandez, Sivye Ashurova, Steven Correa, Suri Abreu, and
Yisel Abella Nunez