November 30, 2010

IRS Examines Professional Athlete Tax Deductions

Excerpts from a presentation at Sports Financial Advisors Association Annual Conference given November 13, 2010

Presented by Mitchell S. Halpern, J.D.  Mitchell is a principal at O’Connor & Drew, P.C., a CPA firm located in Braintree, Massachusetts, where he is the Director of the Firm’s Sports and Entertainment Accounting Practice.  He is also a board member of the Sports Financial Advisors Association and a member of the Sports Lawyers Association.  Mitchell authored the chapter on State and Local Taxation of Professional Athletes that appears in Gary Uberstine’s legal treatise, “Law of Professional and Amateur Sports”, has spoken at numerous national conferences on tax issues relevant to professional athletes and has been quoted in various newspapers. He has also been interviewed on SLT on previous ocassions. We thank him for his premission to present our readers with excerpts from his presentation.

This past Tuesday, there was an article posted on a Forbes blog entitled “Lamar Odom Seeks Tax Deduction for NBA Fines and Fitness Fees”.  This article has since been referenced on many other blogs & websites including ProBasketballTalk (“Lamar Odom Sues IRS Over Deductions”) and Sports Law Blog (“Are NBA fines tax deductible?  Lamar Odom takes on the IRS”).

The gist of the article on the Forbes blog is that Lamar Odom, a player on the Los Angeles Lakers basketball team, filed a tax court petition disputing the disallowance by the IRS of deductions for NBA fines, in the amount of $12,000, and training and conditioning expenses, in the amount of $178,337, resulting in federal taxes owed of approximately $87,000 (including interest, but not penalties).

I’m not here today to discuss with you the legitimacy of these deductions (both of which I believe are legit), but rather to give you the story behind the story. 

What is the story behind the story?  The Lamar Odom story is the result of the IRS selecting his 2007 income tax return for examination.  His examination was most likely what is known as a correspondence examination in which a taxpayer is asked to provide specific documentation for certain items on their tax return.  Over the past year plus, there has been a spike in IRS examinations of the “unreimbursed business expenses” of professional athletes.  I, myself, have been, or am currently, involved with 8 such examinations “that I am aware of”, 3 of which have been resolved with no changes made by the IRS and 5 of which are still in the IRS pipeline.

Why did I say “that I am aware of”?  I say this because not all of my clients are the most diligent at forwarding me notices they receive from the IRS or other taxing authorities.  So I may have other clients that are under examination that I do not yet know about.  This is where you come in as financial advisors that work with professional athletes.  It is important that we are aware of what is going on, and to understand the process, so that we can advise our clients accordingly.  Quite coincidentally, this past Monday, before the Lamar Odom story hit the blogs and websites, one of our members, Peter Wheeler, and I had discussed this very issue and that it would be a great topic to briefly discuss at this year’s conference.  So here I am. 

The IRS correspondence examination process starts out with an initial letter sent by the IRS to the taxpayer indicating that their return has been selected for examination.  This letter will indicate what items are being examined and what documentation is being requested.  For professional athletes, this letter will generally indicate that Schedule A – Itemized Deductions and Unreimbursed Business Expenses are being examined.  The taxpayer has 30 days from the date of the IRS letter to respond.  An extension of time can generally be obtained if requested within this 30 day time frame.

If I am lucky enough to be notified of a client’s IRS examination in a timely manner, I will generally obtain a power of attorney allowing the IRS to deal directly with me and which will also result in my receiving all future correspondence from the IRS with respect to the examination.  Obtaining a power of attorney from the client is always my first step, even if my involvement occurs later in the process. 

If I do not receive notification of the IRS examination from my client, and the client does not otherwise respond to the IRS within the initial 30 day period, the IRS will issue an examination report disallowing deductions for the items they are examining and showing a proposed tax due.  Depending on the deductions involved, the proposed tax due can be substantial.  I have one case in the IRS pipeline where my initial involvement occurred at this point and the proposed tax due was $319,127 (plus interest due of $34,567).  This stage of the process usually gets the client’s attention.  The taxpayer generally has 30 days from the date of the issuance of this examination report to disagree with the proposed changes and provide support, i.e. documentation, for the items disallowed.  While the IRS may tell you, upon a request, that it has extended the period of time to respond to the examination report, its computers will sometimes still proceed to the next step of the process, regardless of any extension previously granted.

Failure to respond to the examination report within the time frame allowed will generally result in the issuance of a Notice of Deficiency in which the IRS will assess the taxes it believes are owed and that gives the taxpayer 90 days to either pay the tax or file a petition with the U.S. Tax Court.  During this 90 day period, the taxpayer can still try to resolve the matter with the IRS, but if the matter is not settled and a tax court petition is not filed within the 90 day period, the taxpayer must pay the tax and then file suit for refund if they wish to pursue the matter further.  Oftentimes the tax court petition is filed to protect the taxpayer’s rights, but attempts to resolve the matter directly with the examiner or an appeals officer will continue.

The conclusion of Mr. Halpern's presentation will be posted tomorrow