This post was originally published on Forbes May 28, 2015
Ever since the travails of poor Tim Geithner, I can't resist looking at a case where TurboTax is involved. Thus I was surprised that the Federal Circuit Appeals decision in the case of Christopher and Judith McNaughton has not attracted more attention. It was interesting enough for me to want to talk to the taxpayer, who was representing himself. Mr. McNaughton practiced corporate law until the early eighties working his way up to corporate counsel of a large company and then going over to the business side and from there into venture capital. In retirement he spends his time managing his investments. He does his own tax return. I tried to give him a hard time about that, but he was too caught up in explaining his grievances to me.
I even spent a few bucks on Pacer and looked at the amended return that was the subject of the Court of Claims decision that Mr. McNaughton was appealing. That return was like the bread and butter of the high net worth group I worked with when I was a partner in a regional firm. And the guy is using TurboTax. He really should be helping some CPA put his kids through college, but so it goes.
Tracking PTP Losses
TurboTax was kind of the source of his problems. He invested in a lot of publically traded partnerships(commonly referred to as master limited partnerships). He thought that TurboTax was tracking the suspended losses for him. He sold a bunch of the PTPs in 2005 and another batch in 2007. For whatever it is worth, Mr. McNaughton, who strikes me as a shrewd investor does not think master limited partnerships are that good a deal for the investors anymore, although they may still be a good deal for the sponsors.
Sometime in 2009 or 2010, Mr. McNaughton was in an internet discussion group of investors like himself. One of them mentioned the problem with TurboTax not tracking the loss carryovers. Mr. McNaughton took a look at his returns and determined that he was due refunds for 2005 and 2007. Some good sized numbers $96,300 for 2005 and $58,600 for 2007.
Court of Claims is Expensive
The story gets a little confusing from here. Apparently the IRS jerked him around quite a bit on the 2007 refund and part of his claim is damages because of that. I get the impression that his read on the situation was that they were using the 2007 refund to pressure him to drop the case on 2005 and the damage claim. Although Mr. McNaughton realizes he is probably in the 1%, he sees himself as battling on behalf of the little guy who doesn't have his staying power.
Mr. McNaughton confirmed something that I had suspected. The $150,000 or so he was seeking from the Court of Claims is a lot of money. But it is small change by Court of Claims standards. That was a sad discovery I made the one time that I had a client take the Court of Claims route. It seemed like a good idea, because of some other considerations, but it is a lot more expensive than Tax Court. Mr. McNaughton who had a lot of experience paying legal bills when he was a general counsel thinks that he would have had to have paid a lot more than the amount of his claims to get the work done that he had done himself.
He was pretty resentful of the manner in which the government was easily granted extensions during the litigation.
Statute Of Limitations
The reason that the 2005 claim was being turned down was that it was past the statute of limitations. Mr. McNaughton was dusting off a regulation (301.6511 (g)-1)) that allowed a four-year statute for claims arising out of partnership items. The IRS argued and the Court agreed that the regulation only applied to items arising between December 31, 1978 and September 4, 1982. Much as I want to root for the taxpayer here, I think the IRS and the Court are probably right. They won't ever convince Mr. McNaughton though and I think he has a really good point in asking why the regulation is still kicking around, if it cannot ever possibly apply to anything.
The IRS had an alternative argument, Code Section 7422(h), which limits the ability of taxpayers to bring refund suits with respect to partnership items. Mr. McNaughton argued that the government had not advanced this argument timely. My own view on that argument, which Mr. McNaughton would have a reason not to raise, is that this whole matter was not really a partnership item. Mr. McNaughton was not arguing about what was supposed to hit his return from the partnerships. It was about the computations on his return after the partnership items were incorporated. Of course, that would totally kill his four-year statute argument.
A Tough Fight
Mr. McNaughton thinks the IRS and the Court of Claims really jerked him around. He told me that it was indicated that the chief counsel was called to weigh in on the case.
Somebody once told me that my problem is that being an Aquarian, I want everybody to get along, so that bias might be behind my theory that there might be a more benign explanation for Mr. McNaughton's difficulties. I think he really threw the IRS for a loop by dusting off that 301.6511 (g)-1. His decisions are the only time that regulation is mentioned in case law and there are no rulings of any kind that mention it. Furthermore, the IRS has been trying to get more time to root out partnership shenanigans, so it is possible that the Service would have been happy if he turned out to be right, hence the chief counsel involvement. Regardless, there is hardly anybody still working for the IRS that would have any reason to know about that regulation.
At any rate, Mr. McNaughton has not given up the fight, although I don't know what his next step is. Even though I don't reach the same conclusion he does, I have to really admire the guy. By the way, he told me that TurboTax has fixed the tracking problem and he is still doing his own return.