Amy Y. Chien v. Commissioner, TC Memo 2012-277 , Code Sec(s)
1; 1401; 3101; 3111; 3121; 6662; 7491.
AMY YU-WEN CHIEN, Petitioner v. COMMISSIONER OF INTERNAL
REVENUE, Respondent .
Case Information:
Code Sec(s): 1;
1401; 3101; 3111; 3121; 6662; 7491
Docket: Docket
No. 24401-10.
Date Issued:
10/1/2012
HEADNOTE
XX.
Reference(s): Code Sec. 1; Code Sec. 1401; Code Sec. 3101;
Code Sec. 3111; Code Sec. 3121; Code Sec. 6662; Code Sec. 7491
Syllabus
Official Tax Court Syllabus
Counsel
Timothy A. Doyle, for petitioner.
Karen Lynne Baker, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: The respondent (the “IRS”) determined that
the petitioner (“Chien”) is liable for deficiencies of $2,278, $6,192, and
$3,845, for tax years 2005, 2006, and 2007, respectively. The deficiencies are
predicated on the following determinations: (1) that the wages Chien received
from the [*2] International Monetary Fund (”IMF”) were includable in her
self-employment income, thus resulting in self-employment-tax liability under
section 1401, and (2) that in calculating Chien's income-tax liability under
section 1, there should be deducted from her taxable income one-half of her
self-employment-tax liability. 1
The notice of deficiency also reflected a determination by
the IRS that Chien is liable for section-6662(a) penalties of $545.60,
$1,238.40, and $769.00, for tax years 2005, 2006, and 2007, respectively. All
references to sections are to sections of the Internal Revenue Code as in
effect for the tax years at issue.
Chien concedes she is liable for the deficiencies. The only
issue remaining for resolution is whether she is liable for the section-6662(a)
penalties. We hold that she is not liable.
FINDINGS OF FACT
Chien resided in California when she filed her petition. She
was a U.S. citizen during the years at issue. While Chien was in college, her
father prepared her tax returns. Chien's first postcollege job was with the
Peace Corps. Her income from the Peace Corps [*3] was below the threshold for
filing tax returns. In 2004 she quit the Peace Corps and began working for
Corestaff Services, L.P., a temporary staffing agency in Washington, D.C. The
first tax return that she prepared herself was her 2004 federal-income-tax
return. She prepared the return by consulting IRS instructions on the internet.
Chien joined the IMF as a staff assistant in July 2005. She
and the IRS have stipulated that she was a “contract employee” of the IMF. She
was initially hired at a salary of $44,540 per year.
Shortly after joining the IMF, Chien met with J. Carter
Magill, an employee of the IMF who was conversant in taxation. The meeting
lasted five minutes. Magill explained to Chien that she had to make an
estimated-tax payment every quarter. Shortly after the meeting, Magill emailed
Chien a spreadsheet that calculated her next estimated-tax payment. Because an
estimated-tax payment is based on the taxpayer's tax liability for the
year,see, sec. 6654(b)(1), (d)(1)(A) and (B), (f)(1), the spreadsheet was based
on Magill's calculation of Chien's tax liability for 2005. The amount of
liability, as calculated on the spreadsheet, included the income tax imposed by
section 1,see sec. 6654(f)(1), and the self-employment tax imposed by section
1401,see sec. 6654(f)(2), with Chien's 2005 IMF wages included in
self-employment income. Had Chien understood that her [*4] estimated-tax
payment was based on her liability for the income tax imposed by section 1 and
the self-employment tax imposed by section 1401, she would presumably have
inferred from the spreadsheet that she would be liable for the self-employment
tax. However, Chien had no such understanding of the estimated-tax regime. So
she made no such inference from the spreadsheet. Other than the spreadsheet,
Chien did not receive any other information from the IMF informing her that she
was considered self-employed or that she was liable for the self-employment
tax. (Later we discuss information Chien received at an IRS presentation on
site at the IMF in January 2007.) During 2005 Chien earned $20,899.58 for her
services to the IMF. On September 15, 2005, Chien made an estimated-tax payment
of $2,906 for 2005.
On January 15, 2006, Chien made another estimated-tax
payment of $2,906 for 2005. On March 27, 2006, Chien prepared a Form 1040, U.S.
Individual Income Tax Return, for the tax year 2005. She timely filed the
return. In preparing the return, Chien consulted the IRS instructions for the
Form 1040. She had been advised by Magill at their meeting that preparing her
federal tax returns would be easy as long as she followed the IRS instructions.
Line 27 of the Form 1040 [*5] stated: “One-half of self-employment tax. Attach
Schedule SE”. In completing line 27, we find that Chien referred to the Form 1040
instructions for line 27. The instructions stated: “If you were self-employed
and owe self-employment tax, fill in Schedule SE to figure the amount of your
deduction.” Believing that she was not self-employed, Chien typed "0” on
line 27 and did not complete a Schedule SE, Self-Employment Tax. Line 58 of the
Form 1040 stated: “Self-employment tax. Attach Schedule SE”. Because she
believed she was not self-employed, Chien typed "0” on line 58 and did not
attach Schedule SE. Chien never read the IRS instructions for completing
Schedule SE. 2 If she had read the instructions, she would have found this
statement on the first page:
You must pay SE tax on income you earned as a U.S. citizen
employed by a foreign government (or, in certain cases, by a wholly owned
instrumentality of a foreign government or an international organization under
the International Organizations Immunities Act) for services performed in the
United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the
Northern Mariana Islands (CNMI), or the Virgin Islands. *** Thus, she would
have learned that even though she was not “self-employed” in the usual meaning
of the term, she might still be required to report and pay self-employment tax.
Instead, Chien mistakenly thought because that she was not [*6] “self-employed”
in the usual meaning of the term, she was not liable for the self-employment
tax. She made this same mistake when she prepared her Forms 1040 for the 2006
and 2007 tax years.
The Form 1040 for 2005 reported wage income of $28,823,
which included the $20,899.58 that Chien had received from the IMF and $7,923
in wages that she had received from Corestaff Services, L.P. On line 44, which
is the place on Form 1040 for reporting the income-tax liability imposed by
section 1, she reported a tax liability of $2,168. She reported that “Federal
income tax withheld from Forms W-2 and 1099” was $613. She reported that the
sum of her 2005 estimated-tax payments and the amount applied from her 2004
return was $2,906. (Her actual estimated-tax payments for 2005 totaled $5,812.
The $2,906 amount that she reported apparently included only one of her two
estimated-tax payments.) She reported she had made total payments of tax of
$3,519 and requested a refund of $1,351. Attached to the Form 1040 was a Form
W-2, Wage and Tax Statement, from Corestaff Services, L.P. It reflected that
she had been paid wages of $7,923, that $613.39 of federal-income tax had been
withheld from her wages, that $491.23 in Social-Security tax had been withheld
from her wages, and that $114.88 in Medicare tax had been withheld from her
wages. Also attached was a Form W-2 from the IMF. It reflected that she had
been paid wages of $20,899.58. [*7] The word “NONE” was printed under “Federal
income tax withheld”. The word “NONE” was printed under “Social Security tax
withheld”. There was no entry for “Medicare tax withheld”.
In 2006 Chien earned $50,017.07 for her services to the IMF.
On or about April 13, 2006, Chien made an estimated-tax
payment of $2,771 for 2006.
On April 24, 2006, the IRS paid Chien a $4,257 refund of
income tax for 2005. The payment was equal to the $2,168 of tax that Chien
reported on her tax return minus her $6,425 of payments (i.e.: (1) withholding
by Corestaff Services, L.P., of $613, (2) the September 15, 2005 estimated-tax
payment of $2,906, and (3) the January 15, 2006 estimated-tax payment of
$2,906).
On or about September 10, 2006, Chien made another
estimated-tax payment of $2,000 for 2006.
On or about January 9, 2007, Chien made an estimated-tax
payment of $2,000 for 2006.
On January 9, 2007, Shirley Kelly, a representative of the
IRS, delivered a slide presentation to IMF employees to educate them about
their tax responsibilities. Attendance at the presentation was not mandatory.
Chien's duties caused her to be late to the presentation. She arrived only a
few minutes [*8] before the end, but she picked up a copy of the slides. Chien
looked over the slides later. If Chien was knowledgeable about taxes, she could
have realized from the slides that her IMF wages were subject to
self-employment tax. The fourth slide advises that “In general, U.S. citizens
employed at the International Monetary Fund are subject to both U.S. income tax
and Social Security taxes on the gross amount of their wages.” The eighth slide
says:
Employees of Embassies and International Organizations U.S.
Citizens working in the U.S. Your employer files a W-2 form with the Internal
Revenue Service, but does not withhold U.S. taxes.
Your responsibilities for this wage income: —Report wages on
Form 1040, Line 7 —Complete schedule SE for self-employment tax on your wage
income —Make Estimated Tax Payments When asked at trial to explain how she
could not have understood from the slides that she should have reported her IMF
wages as self-employment income, Chien said that when she read the slides she
would not have immediately understood the meaning of many of the terms used.
For example, she testified—credibly—that she would not have understood the
difference between income tax and self- [*9] employment tax or the relationship
between estimated-tax payments and self-employment tax. Also, we find that
Chien missed the portion of the slide presentation in which Kelly had orally
explained the two slides we referred to above. Chien did not later make a
sustained effort to understand the slides in the sense that she did not analyze
what was meant by the various phrases used. Nor did she analyze how the phrases
used in the slide presentation corresponded to the phrases used in the Form
1040 and the instructions to the Form 1040. Instead, having missed most of the
slide presentation, the lesson that Chien took away from the event was that she
should follow the Form 1040 instructions.
On April 6, 2007, Chien prepared a Form 1040 for the 2006
tax year. She timely filed the return. Her reporting was similar in most
respects to that on the Form 1040 she had filed for 2005. As on her 2005
return, she reported her IMF wages as wage income. She also reported that she
had no self-employment income and did not owe self-employment tax.
The Form 1040 for 2006 reported wage income of $50,017,
which was the $50,017.07 that Chien had received from the IMF. On line 44,
which is the place on Form 1040 for reporting the income-tax liability imposed
bysection 1, she reported a tax liability of $6,839. She reported no
self-employment tax. She did not attach Schedule SE. She reported that “Federal
income tax withheld from [*10] Forms W-2 and 1099” was zero. She reported that
the sum of the 2006 estimated-tax payments and the amount applied from her 2005
return was $6,771. (Her actual estimated-tax payments for 2006 totaled $6,771,
i.e. $2,771 + $2,000 + $2,000.) She reported that she had made total payments
of $6,801 (including a $30 credit for payment of the federal telephone excise
tax) and that she owed a balance of $38. Attached to the Form 1040 was a Form
W-2 from the IMF. It reflected that she was paid wages of $50,017.07. The word
“NONE” was printed under “Federal income tax withheld”. The word “NONE” was
printed under “Social Security tax withheld”. There was no entry for “Medicare
tax withheld”.
In 2007 Chien earned $29,441.05 for her services to the IMF.
She also received $2,500 in wages from a source not disclosed by the record.
On or about April 12, 2007, Chien made an estimated-tax
payment of $2,000 for 2007.
In the middle of 2007 Chien left her position with the IMF
to attend school.
On or about June 16, 2007, Chien made an estimated-tax
payment of $2,000 for 2007. On or about September 8, 2007, Chien made another
estimated-tax payment of $2,000 for 2007. [*11] On December 10, 2007, the IRS
paid Chien a $2.10 refund of income tax for 2006. The refund was not equal to
the tax reported on the Form 1040 (i.e. $6,839) minus estimated-tax payments
(i.e. $2,771 + $2,000 + $2,000) because, in calculating the refund, the IRS had
made other allowances for various payments, refundable credits, and interest.
On April 7, 2008, Chien prepared her Form 1040 for the 2007
tax year. She filed the return timely. As on her 2005 and 2006 returns, she
reported her IMF wages as wage income. She also reported that she had no
self-employment income and did not owe self-employment tax.
The Form 1040 for 2007 reported wage income of $31,941,
which comprised the $29,441 that she had received from the IMF and the $2,500
in other wage income. On line 44, which is the place on Form 1040 for reporting
the income-tax liability imposed by section 1, she reported a tax liability of
$3,093 (before subtracting a $2,000 credit). She reported no self-employment
tax. She did not attach Schedule SE. She reported that “Federal incometax
withheld from Forms W-2 and 1099” was zero. She reported that the sum of the
2007 estimated-tax payments and the amount applied from her 2006 return was
$2,000. (Her actual estimated-tax payments totaled $6,000, i.e. $2,000 + $2,000
+ $2,000). The Form 1040 reported that she had made total payments of $2,000
(the sum of her [*12] reported estimated-tax payments but not the $2,000
credit), and it requested a refund of $907. Attached to the Form 1040 was a
Form W-2 from the IMF. It reflected that she had been paid wages of $29,441.05.
The word “NONE” was printed under “Federal income tax withheld”. The word
“NONE” was printed under “Social Security tax withheld”. There was no entry for
“Medicare tax withheld”.
On May 5, 2008, the IRS paid Chien a $4,907 refund of her
2007 income taxes. This amount was equal to the $1,093 that she reported as her
tax liability on her Form 1040 minus her $6,000 in estimated-tax payments.
OPINION
The Federal Insurance Contributions Act (”FICA”) tax is
imposed on “wages” paid with respect to “employment”. Secs. 3101(a) and (b),
3111(a) and (b). The employer is liable for half of the FICA tax. Sec. 3111(a)
and (b). The employee is liable for the other half of the FICA tax, sec.
3101(a) and (b), but the employer must withhold this portion of the tax from
the employee's wages as it pays the employee, sec. 3102(a). Amounts so withheld
are credited by the IRS to the account of the employee. See Slodov v. United
States, 436 U.S. 238, 243 [42 AFTR 2d 78-5011] (1978). The term “employment” is
defined by section 3121(b) as: [*13] any service, of whatever nature, performed
(A) by an employee for the person employing him, irrespective of the
citizenship or residence of either, (i) within the United States, or (ii) on or
in connection with an American vessel or American aircraft under a contract of
service which is entered into within the United States or during the
performance of which and while the employee is employed on the vessel or
aircraft it touches at a port in the United States, if the employee is employed
on and in connection with such vessel or aircraft when outside the United
States, or (B) outside the United States by a citizen or resident of the United
States as an employee for an American employer (as defined in subsection (h)),
or (C) if it is service, regardless of where or by whom performed, which is
designated as employment or recognized as equivalent to employment under an
agreement entered into under section 233 of the Social Security Act; except
that such term shall not include— *** (15) service performed in the employ of
an international organization *** An international organization is defined by
section 7701(a)(18) as “a public international organization entitled to enjoy
privileges, exemptions, and immunities as an international organization under
the International Organizations Immunities Act (22 U.S.C. sec. 288-288f)”. It
is undisputed that the IMF is such an international organization. Under section
3121(b)(15), service performed in the employ of an international organization
such as the IMF is not “employment”. Payment for such service is therefore not
subject to the FICA tax.
The self-employment tax is a tax on the self-employment
income of an individual. Sec. 1401(a) and (b). Self-employment income is
defined as net [*14] earnings from self-employment. Sec. 1402(b). Net earnings
from self-employment is generally defined as income from a “trade or business”,
minus deductions. Sec. 1402(a). The term “trade or business” is generally
defined as excluding “the performance of service by an individual as an
employee”, but the performance of service by an individual as an employeeis considered
a “trade or business” if it is a “service described in *** [ section
3121(b)(15)] performed in the United States *** by a citizen of the United
States”. Sec. 1402(c)(2)(C). Because service performed by an employee of the
IMF is undisputedly described in section 3121(b)(15), the performance of
service within the United States by a U.S.-citizen employee of the IMF is
considered a “trade or business”. Income from such service is therefore subject
to the self-employment tax. See Braddock v. Commissioner, 95 T.C. 639, 643-644
(1990) (service performed for International Telecommunications Satellite
Organization); Smart v. United States, 222 F. Supp. 65 [12 AFTR 2d 5813]
(S.D.N.Y. 1963) (service performed for United Nations), aff'd, 332 F.2d 283 (2d
Cir. 1964).
One-half of the amount of self-employment-tax liability for
the year is deducted in calculating taxable income for purposes of the income
tax imposed by section 1. Sec. 164(f)(1). [*15] The IRS contends that Chien is
liable for the section-6662(a) penalty for each of her tax years 2005, 2006,
and 2007 because, it contends, her underpayments of tax for these three years
were due to negligence or disregard of rules or regulations and her
underpayment of tax for 2006 was due to a substantial understatement of income
tax. Section 6662(a) imposes an accuracy-related penalty equal to 20% of an
underpayment attributable to a substantial understatement of income tax or
negligence or disregard of rules or regulations. Sec. 6662(a) and (b)(1) and
(2). A substantial understatement of income tax exists if (1) the
understatement is greater than 10% of the income tax required to be shown on
the return, and (2) the understatement is greater than $5,000. Sec.
6662(d)(1)(A). Negligence includes any failure to make a reasonable attempt to
comply with the tax laws. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
Negligence is strongly indicated where a taxpayer fails to make a reasonable
attempt to determine the correctness of a deduction, credit, or exclusion that
would seem to a reasonable person to be “too good to be true”. Sec.
1.6662-3(b)(1)(ii), Income Tax Regs.
The accuracy-related penalty does not apply to any portion
of an underpayment if it is shown that there was reasonable cause for, and that
the taxpayer acted in good faith with respect to, such portion. Sec.
6664(c)(1). In [*16] determining whether the taxpayer acted with reasonable
cause and in good faith, the guidance in section 1.6664-4(b)(1), Income Tax
Regs., is applicable:
Generally, the most important factor is the extent of the
taxpayer's effort to assess the taxpayer's proper tax liability. Circumstances
that may indicate reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in light of all of the facts
and circumstances, including the experience, knowledge, and education of the
taxpayer. ***
The IRS has the burden of production under section 7491(c)
with respect to the accuracy-related penalty. To meet that burden, the IRS must
come forward with sufficient evidence that it is appropriate to impose this
penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Although the IRS
bears the burden of production with respect to the accuracy-related penalty,
the IRS “need not introduce evidence regarding reasonable cause, substantial
authority, or similar provisions.” Id. The taxpayer “bears the burden of proof
with regard those issues.” Id.
The IRS is correct that for the tax year 2006 Chien had an
underpayment attributable to a substantial understatement of income tax. The
understatement of income tax on her 2006 return was $6,192. This is greater
than 10% of the tax required to be shown on the return (i.e. $1,303.10, or 10%
of $13,031). It is also greater than $5,000. Therefore Chien had a substantial
understatement of income tax for 2006. [*17] The IRS also contends that Chien
was negligent or disregarded rules and regulations in preparing her returns for
all three tax years. The IRS has multiple theories as to how Chien was
negligent. First, Chien failed to seek further advice from Magill to clarify
whether she was liable for the self-employment tax. Second, Chien attended
Kelly's presentation at the IMF and/or reviewed the slides; thus she should
have known that she was liable for self-employment tax. Third, the tax Chien
reported was far exceeded by her estimated-tax payments, and she received
refunds for all three tax years; thus she should have realized that she had
likely misreported her tax liabilities. For these and other reasons, the IRS
also contends that Chien did not have reasonable cause for failing to report
her IMF wages as self-employment income and did not act in good faith with
respect to this omission.
We find that Chien had reasonable cause for failing to
report her IMF wages as self-employment income and that she acted in good faith
with respect to this omission within the meaning of section 6664(c)(1). Chien's inexperience was the reason she
failed to understand—from her interactions with Magill, from the IMF slide
presentation, or from the disparity between her estimated-tax payments and her
reported tax liability—that she was liable for the self-employment tax on her
[*18] IMF wages. She consulted the instructions for the Form 1040. 3 She formed
the impression that she did not need to report her wages as self-employment
income on the Form 1040 and the Schedule SE, because, in the words of the Form
1040 instructions, she was “not self-employed.” Chien made an honest mistake in applying the instructions. Thus, she qualified
for the reasonable-cause-and-good-faith exception to the section-6662(a)
penalties.
To reflect the foregoing and concessions,
Decision will be entered for respondent as to deficiencies
and for petitioner as to the section 6662(a) penalties.
Johnson was the proper tax treatment of a transaction, not
whether the taxpayer was liable for the accuracy-related penalty. It is
therefore distinguishable.
1
Although we refer to
the tax imposed by sec. 1401 as the self-employment tax, it is treated as an
income tax for purposes of sec. 6662 (which imposes a penalty on underpayments
attributable to any substantial understatement of income tax). See sec.
1.6662-4(a), Income Tax Regs.; Cameron v. Commissioner, 98 T.C. 123, 126
(1992), aff'd without published opinion , 15 F.3d 1083 [73 AFTR 2d 94-786] (9th
Cir. 1994).
2
These instructions
were entitled “Form SE-1, 2005 Instructions for Schedule SE (Form 1040)”.
3
The IRS cites
Johnson v. Commissioner, 620 F.2d 153, 155 (7th Cir. 1980), aff'g T.C. Memo.
1978-426, for the proposition that “a taxpayer may not rely on an informal IRS
publication if it is inconsistent with the statute.” The issue in Johnson was
the proper tax treatment of a transaction, not whether the taxpayer was liable
for the accuracy-related penalty. It is therefore distinguishable.
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