Reliance on tax software does not let taxpayer off the hook

A recent Tax Court case provides a cautionary tale for taxpayers who rely on do-it-yourself tax preparation software to prepare their tax returns. In the case, the Tax Court held that a taxpayer couldn’t blame his tax prep software for deductions that he took on his tax return that were disallowed (Bulakites, T.C. Memo. 2017-79).

Barry Bulakites is an insurance consultant who used TurboTax to prepare his own returns. The IRS believed he claimed too many deductions, but Bulakites argued that he had enough evidence to prove some of them and, according to the Tax Court, blamed the software for “luring him into claiming others.”

TurboTax, which is aimed at individual taxpayers preparing their own returns, asks the user a series of questions and then fills out the tax return based on those answers. The problem is that sometimes the user doesn’t understand the questions.

The main issue in Bulakites’s case arose from a lawsuit in which Bulakites was a defendant. In 2007, the settlement of that lawsuit left him liable for $500,000.

Bulakites said he paid the settlement by taking out a $500,000 loan secured by his home. Bulakites planned to sell his home and use the proceeds to pay the note when it came due. However, because of the start of the Great Recession, he was unable to sell his house and he managed to pay only a fraction of what he owed.

Bulakites claimed interest deductions on the loan of $31,000 for 2011 and $48,000 for 2012. The court acknowledged that he paid the interest to the lender, but the amount paid did not match the amount deducted on the return. Bulakites did not produce any paperwork to show what had happened to the original loan, which was originally due to be paid off in 2008. The court said it could not figure out if the loan had been extended or refinanced: “Without any paperwork (in a situation where there should have been lots of paperwork) we are left only with his testimony about the total amounts of the payments and the allocation of those payments between principal and interest” (slip op. at p. 7). Finding Bulakites to be a less-than-credible witness, the court upheld the IRS’s disallowance of the entire amount of his interest deduction for both years

In 2009, Bulakites and his wife legally separated, and they divorced a year later. Under their separation agreement, Bulakites was to pay $2,000 per month in spousal support to his ex-wife until he sold the marital residence. After that, the payments would increase to $8,000.  

Bulakites and his ex-wife never entered into any subsequent maintenance agreements, but because he could not sell the house, and to do “the right thing,” Bulakites orally agreed with his ex-wife to increase his payments to her to $5,000 per month. According to the Tax Court, he paid his ex-wife about $50,000 in both 2011 and 2012. Bulakites deducted these payments as alimony in the years at issue (2011 and 2012), but the court ruled that the oral agreement he had with his ex-wife wasn’t sufficient to modify the couple’s separation agreement and therefore the payments did not qualify as alimony.

Bulakites also claimed a net operating loss (NOL) of $185,673, all but $142 of which the IRS disallowed. The court noted that, to claim an NOL, a taxpayer is required to substantiate the claim to the deduction by filing “a concise statement setting forth the amount of the net operating loss deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the net operating loss deduction” (slip op at p. 8). Bulakites failed to provide this documentation at trial. He submitted a return for a previous year but not for the year in which the NOL arose. Therefore, the court found that the IRS had properly determined that Bulakites was not entitled to an NOL deduction.

Finally, the court addressed the IRS’s imposition of accuracy-related penalties under Sec. 6662(a) for substantial understatements of income tax for both 2011 and 2012. Bulakites tried to blame TurboTax for his mistakes, but the court rejected his claim and upheld the penalties, quoting another Tax Court case, Bunney, 114 T.C. 259, 267 (2000), “[t]ax preparation software is only as good as the information one inputs into it” (slip op. at p. 9).

Craig W. Smalley is an enrolled agent and the founder and CEO of CWSEAPA PLLC, which provides accounting and financial services.