Case of the cavalier Internal Revenue Service agent

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Shouldn't an Internal Revenue Service agent know a business when she sees one - especially if she is the owner and operator?

After the IRS initiated a criminal investigation against Revenue Officer Andrea Fabiana Orellana in 2006, it was determined that she owed $14,912 in back taxes and penalties. Apparently confident of her knowledge of tax law, Orellana then petitioned the U.S. Tax Court, hoping for a different opinion.

The case presented by the IRS maintained that Orellana failed to report and pay taxes on nearly $36,000 of income she earned selling items on eBay, an online auction site. In her own defense, she said she didn't consider herself to be in business. She thought of her operation as more of an online garage sale. That also may have explained why she did not keep receipts and other records. But the court said this was not an acceptable defense.

Details of her self-defense

In more than 7,000 transactions, Orellana sold items such as designer clothing and shoes on eBay from 2000 to 2005. She told the court that she was just selling things that were taking up space in her closet. For example, she said, she might sell a $350 pair of shoes that she no longer wanted for $50. Some of the items were wedding gifts, she said, while others were bought with gift cards that were wedding gifts. She admitted that some of the items she sold still had price tags attached.

In court she was reminded by the IRS that she advertised many of the items as new. To that, she answered: "I always advertise as new only because you can get a better price for that." And she added",So basically when you're asking these questions about why things are new, I document them as new if it appears new. Is that wrong?"

During the proceedings, IRS officials pointed out that she sold clothes and shoes in a variety of sizes, which seemed contrary to her claim that she was only selling items she'd purchased for herself. She responded that, because of a physical condition, she had been unable to maintain her exercise routine and her size had changed over time. As for the shoes being different sizes, she testified that the use of orthotics had made her shoe size increase.

When the IRS asked her to produce receipts and records of her expenses, she reiterated that she'd bought or been given the items for personal use, so there was no need to keep receipts. She told the court: "That would be ridiculous, unheard of. Unless there was some really bizarre reason why I kept a receipt, there were no receipts."

Orellana did attempt to provide proof of expenses by creating two charts based on her bank statements and PayPal records. Investigators attempted to use her documentation to prove expenses, but stated that Orellana left a meeting with revenue agents and was unavailable to assist them. For many of the expenses listed, such as the cost of items sold, there was no evidence to prove the basis of the items, therefore the costs were disallowed. In the end, Orellana was permitted to claim reasonable expenses such as postage, eBay fees, and bubble wrap.

To reconstruct her income without records, investigators summonsed her bank statements from Washington Mutual Bank and PayPal, and from a Sharebuilder Securities Corp. brokerage account. Records of sales also were subpoenaed through eBay and PayPal. Orellana did not accept the IRS's determination of her income, stating that it had to be flawed because different people, including the investigators, were looking at the same documents but coming up with different numbers.

According to the calculations presented by the IRS, Orellana owed $5,326 for tax year 2004, plus an accuracy-related penalty of $1,065.20; and an additional $7,101.75 for 2005, plus an accuracy-related penalty of $1,420.35.

What did the Tax Court conclude?

The court found Orellana's "attitude toward the preparation of her tax returns to be cavalier." She told the court she had been preparing tax returns since she was 16 years old and "would never look at the instructions." The court included those comments when it noted that she evidently did not read the instructions that told her to report "other income."

The court added that Orellana is a "revenue officer with the IRS. With that background, she has a wider range of knowledge of tax matters than do members of the general public. ...We have considered the other arguments of the parties, and they are either without merit or not necessary in view of our resolution of the issues in this case."

Bottom line, while many IRS employees are honest and well-trained, it's no guarantee that they are well-versed in tax law or likely to follow it. In Orellana's case, the Tax Court affirmed the IRS's conclusion that she owed back taxes and penalties amounting to $14,912. Read more about the court's opinion here.

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