Charles Rubin discusses the recent case of a taxpayer in the medical supply business who received payments from Cigna prior to 2005 that he reported as income and paid federal tax upon. Rubin explains,
A dispute later arose and the taxpayer returned payments to Cigna. He did not deduct the repayments in the year of repayment, even though Code Section 1341 might have allowed it.
In 2010, Cigna paid the funds back to the taxpayer in resolution of the dispute. The taxpayer did NOT report those payments, reasoning that he had already paid income tax on them the first time he received them.
The IRS disagreed, and the Tax Court concurred – the taxpayer was required to include the 2010 payments in income. Maybe this is the correct technical result, but there is no doubt here that the taxpayer did pay tax twice on the same income. Sometimes that expression “the law is an _ss” is absolutely true.
Perhaps the tax year(s) for the refunding he made had not expired, and he was able to file a refund claim and gain some type of tax benefit to offset the double tax – since the opinion is silent in that regard, I am guessing the taxpayer did not.
Worse yet, the taxpayer got hit with a substantial underpayment of tax penalty. That penalty does not apply if the taxpayer acted with reasonable cause. I would think that a lay taxpayer could easily believe that the income taxed before 2005 was the same income that he received in 2010 and that he need not pay tax on it again, and thus such a belief would be reasonable. The Tax Court did not, perhaps on facts not disclosed in the opinion, and it upheld the penalty.
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Posted by Allison Trupp, Associate Editor, Wealth Strategies Journal