Loopholes for Us All

The IRS constantly is challenging what taxpayers do on matters ranging from property tax to medical payments. Sometimes the taxpayers beat back those challenges. How you can benefit big-time from some recent taxpayer victories…


In one recent Tax Court case, the mother of a home owner named Judith Lang had paid the city the $6,840 in property taxes that Judith owed. The mother also paid Judith’s medical expenses of $27,776 directly to her doctors. Judith included the real estate taxes and medical costs among her itemized deductions in filing her federal income tax forms. The IRS rejected the deductions, and Judith challenged that rejection in Tax Court.

IRS Position: Judith cannot deduct the payments because she did not make them — someone else (her mother) did.

TAX COURT RULING: Judith can deduct the expenses paid by her mother. The court views the situation as if the mother made a gift to the daughter, who then paid her taxes and medical costs herself.

Note: In this case, the mother was not subject to any gift tax, because the amount of the real estate tax was less than the annual gift-tax exclusion ($12,000 at that time… $13,000 in 2011). Payments of medical expenses directly to doctors and hospitals in any amount are free of gift tax.

Better way: To avoid any IRS challenge, anyone who wants to help a friend or relative pay taxes is advised to make a gift of cash to the friend or relative, who then can use the money to pay his/her taxes.

(Judith F. Lang, Tax Court Memo 2010-286)


For a number of years, home owners have been complaining about corrosive drywall (called “Chinese drywall” because much of it was imported from China between 2001 and 2009). The drywall destroyed wiring and other building components, as well as appliances, and produced sulfur gas odors. The issue for taxpayers who are not fully covered by homeowners insurance for the damage: Should this be considered a tax-deductible casualty loss, which would require that it involve a sudden, unexpected event (such as a fire or storm)… or a nondeductible loss from progressive deterioration (such as termite damage)?

IRS Position: Initially, the IRS said that it would not allow a deduction, but eventually it reconsidered. Bowing to pressure from taxpayers and congressional leaders in 23 states, the IRS decided that damage from corrosive drywall is a casualty loss. Home owners who pay for repairs can use the cost of repairs as the amount of their loss and can take the deduction in the year that they pay for the repairs.

If home owners sued or plan to sue the manufacturer or other party, then under a special “safe harbor” provision created by the IRS, they can deduct 75% of the unreimbursed repair costs right away — they do not have to wait until litigation is finished.

What to do: Home owners must check whether their drywall is “problem drywall” (see guidelines from the Consumer Product Safety Commission and the Department of Housing and Urban Development at www.cpsc.gov/info/drywall/InterimIDGuidance012810.pdf). When claiming the deduction for corrosive drywall, complete IRS Form 4684, Casualties and Thefts, and write “Rev. Proc. 2010-36” across the top.

Note: Only taxpayers who itemize can benefit from this ruling. According to the IRS, the taxpayer must first reduce the loss by $100 ($500 if repairs were made in 2009 and an amended return is filed for that year). Also, the taxpayer must reduce the total cost of the loss by 10% of adjusted gross income. Only the excess over the $100 and 10% limit is deductible.


In a case that could benefit employees, the bankruptcy trustee for Quality Stores, Inc., challenged the IRS in bankruptcy court in Michigan seeking a tax refund of more than $1 million of Social Security and Medicare (FICA) taxes. The chain of stores, which sells agriculture-related merchandise, had paid the tax on severance benefits that it gave to former employees when it closed 63 stores and nine distribution centers. After the bankruptcy court backed the trustee’s challenge, the IRS appealed to a Federal District Court.

IRS Position: The severance payments are “wages” that are subject to Social Security and Medicare payroll taxes under the Federal Insurance Contributions Act (FICA).

DISTRICT COURT RULING: These severance payments are not wages. Instead, the court ruled that the severance payments are akin to Social Security payments made to retired or disabled employees — these payments are not subject to FICA.

What to do: Ex-employees who received severance payments within the past three years and had FICA taxes withheld from their checks can ask their former employers whether the company has received a refund of these taxes and then ask for a rebate of their portion of FICA taxes. If a business does not share its refund, affected employees can request in writing a refund from the IRS.

(Quality Stores, Inc., District Court, Michigan. February 23, 2010)


Sung Huey Mei Hsu, who was single at the time, co-owned a home with another single person, and they sold it for a total gain of about $530,000, splitting the profits in half. She claimed a $250,000 tax exclusion on her half of the profit and reported a taxable gain of less than $15,000.

The amount of the allowable exclusion is up to $250,000 for singles and $500,000 for married couples if the owners have owned and used the home for at least two of the five years before the sale date.

IRS Position: Home owners who are single are restricted to a total profit of $250,000 per home, not per owner, before they have to pay the tax, so a single co-owner’s limit would be $125,000, not $250,000.

TAX COURT RULING: The Tax Code does not restrict the total exclusion to $250,000 when there are two single co-owners. IRS regulations even contain an example of unmarried joint owners, both holding a 50% share, who are each allowed a tax-free limit up to $250,000.

What to do: Unmarried home owners who have sold their residences and reported a taxable gain based on their belief that they were required to share the $250,000 exclusion can file an amended return requesting a $250,000 exclusion for each. Generally, they need to act within three years of the due date of the federal tax return on which the sale was reported.

(Sung Huey Mei Hsu, Tax Court Summary Opinion 2010-68)

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