With the internet bringing know-how and information so easily within grasp, this is the DIY age. From buying and selling on Craigslist and eBay, to becoming a landlord on airbnb, we have fully embraced the DIY mentality. YouTube has an amazing amount of instruction for the DIYer, breaking down all kinds of barriers.
The photographer I used for a headshot told me that, when he was starting out, he had to pay $2,000 for a course on lighting that is free today on YouTube. When I was looking for inspiration on marketing methods in preparation for opening my own firm, I mined YouTube for a wealth of free material that I have yet to fully consume. And when I went on my first skiing trip not long ago after a 15-year hiatus, where do you think I turned for pointers on my downhill technique?
Even in as technical an area as tax law, Google has matured into an excellent resource. The Google algorithm consistently hones into the substantive topic that I’m targeting better than the tax databases that I use. It doesn’t have the full range of content or reliability that tax practitioners need, but it can be an excellent starting point.
Although I consider myself a consummate DIYer, I know when I am out of my depth. In our last house, I began taking on more challenging home improvement projects. But when the basement started leaking following a heavy rain, it was time to call a contractor.
Unfortunately, in the area of tax law, some DIYers have had unfortunate experiences when they have tried to do it all on their own. For example, in one recent case, a taxpayer argued against the imposition of penalties because (he argued), as an engineer, he could not be expected to be familiar with all the nuances of tax law. That taxpayer learned that the “engineer” defense only takes you so far. Yes, the Tax Court even expects non-tax professionals to be aware of the alternative minimum tax (AMT) and the net investment income tax.
The engineer defense may have been of greater help at an earlier stage of tax controversy such as the IRS audit or IRS appeals stage. But the taxpayer in that case did not even need to consult a tax professional. TurboTax, perhaps the ultimate DIY tax tool, calculates AMT (as I have painfully learned when I have used TurboTax myself) and the net investment income tax .
Other tax DIYers have learned similar lessons. One of my favorite recent cases involves the sale of a golf business in Florida that was majority-owned by a private equity fund with a minority interest by the original founders (two brothers). For more on that case, I will post a future discussion, so stay tuned!
Suffice to say, this DIY tax experiment did not turn out well for the brothers. It was the tax equivalent of the halfway completed renovation sold at a fire sale price. The brothers did not consult their accountant or a tax lawyer before they agreed to sell their membership interest in their family business. While surprising, this is perhaps understandable given that: (1) they had just sold most of their equity in the business less than four years earlier and (2) they were apparently not entitled to any of sale proceeds because the cash investors came first in priority.
Perhaps the brothers reasoned that they did not need to seek tax advice since they were not receiving any sale proceeds for their membership interest. But acting on the advice of their accountant after the sale, they claimed an ordinary loss on the basis of abandonment. At some later point during the IRS audit, the brothers and the accountant realized that the abandonment position would fail. (See my future post for more on abandonment, which did not work in this case in part because the business was, like many private equity-owned portfolio companies, leveraged at the time of sale.)
The brothers then pivoted to a different position: they claimed that they were entitled to sale proceeds but that they agreed to pay the cash to the private equity owner. The cash proceeds generated tax basis in an amortizable intangible asset in a holding company that owned the business’s real estate. Instead of claiming an abandonment loss, the brothers claimed tax deductions from the amortization of the intangible asset.
Unfortunately, the brothers seemed to lack any documentation supporting their claim that they had a right to any sale proceeds. They lost the Tax Court case and failed to qualify for any ordinary loss or tax deduction. Instead, they have to contend with the severe limitations on claiming capital losses.
The Watts case is an extreme example, but it shows the limits of tax DIY. All the tools and resources available to taxpayers can be extremely helpful, but when the stakes are high taxpayers are better off receiving professional advice before entering into multi-million dollar transactions.