Remember when Treasury Secretary Timothy Geithner ran into trouble because he hadn’t paid his self-employment tax? There was quite a political stir because it meant a tax-evader would be in charge of the IRS.
Geithner had worked at the International Monetary Fund from 2001 to 2004. During those four years, he paid no social security or Medicare taxes. American citizens who are IMF employees don’t have FICA and Medicare tax withheld from the paychecks because it is an international agency. They are considered to be self-employed and are supposed to treat the income as "self-employment" earnings, paying both employer and employee payroll taxes on the income.
The IRS audited Geithner in 2006 and discovered the problem for his 2003 and 2004 returns. Geithner paid just under $17,000 at the time, and the IRS waived any possible penalties. A three-year statute of limitations precluded the IRS from auditing the 2001 and 2002 tax returns. Geithner didn’t volunteer to look over 2001 and 2002 returns even though they contained the same mistake as the 2003 and 2004 returns. The additional amounts for 2001 and 2002 ($25,000) were discovered by the Obama vetting team and Geithner promptly paid up.
Mr. Geithner testified before Congress that he self-prepared his returns using Turbo Tax and that the error was a careless mistake. He paid his over-due social security taxes without penalty, and went on to become the Secretary of the Treasury. Did you ever wonder if it would work for the rest of us?
On June 21, 2010, the U.S. Tax Court handed down a decision in the case of another IMF employee, David Cameron Parker. Mr. Parker also failed to pay self-employment tax, used Turbo Tax to self-prepare his tax returns, and due to that fact argued that he had reasonable cause and acted with good faith with regard to the underpayment. Mr. Parker initiated contact with the IRS and voluntarily came forward with the problem, requesting a waiver of penalties. (He wasn’t caught in an audit.)
From May 25, 2005 through 2006, Mr. Parker earned gross annual compensation of approximately $175,000 while working for the IMF. On his 2005 return, Mr. Parker reported a tax liability of $20,212, which was about $12,000 less than what he actually owed. He asserted that he believed Turbo Tax included the self-employment tax in the tax he owed. He claimed that he called TurboTax and specifically asked "an expert" if self-employment taxes were included. He claimed the "expert" said they were included.
The Court did not believe such a conversation took place, since there were no self-employment taxes shown on the return. As for acting in "good faith" by initiating contact with the IRS regarding the underpayment, good faith must be shown before and during the act of filing. No later acts are included in the "good faith" definition. The IRS refused to waive penalties and the Tax Court backed up the IRS. Here is an excerpt from the opinion, Parker v. Commissioner, T.C. Summ. Op. 2010-78 (June 21, 2010):
"We shall address briefly petitioner’s contention that the IRS granted "favorable treatment" in a case involving U.S. Secretary of the Treasury Timothy Geithner, which petitioner described as "incredibly similar" to the instant case. According to petitioner, "there should not be different, or favorable rules for the well-connected". The record in this case does not establish any facts relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner. In any event, those facts would be irrelevant to our resolution of the issue presented here. Regardless of the facts and circumstances relating to the case to which petitioner refers involving U.S. Secretary of the Treasury Timothy Geithner, petitioner is required to establish on the basis of the facts and circumstances that are established by the record in his own case that there was reasonable cause for, and that he acted in good faith with respect to, the underpayment for each of his taxable years 2005 and 2006 that is attributable to his failure to report self-employment tax."
Similarly situated taxpayers should be treated similarly. The Tax Court was not necessarily wrong in the Parker case. There are other cases holding that reliance on tax preparation software is not enough to escape penalties. The problem is that Geithner should have had to pay the penalty as well.