Tax Brake with Robert G. Nath, Esq.

What to do in such a situation. Some people play ostrich: Forget the deduction. Others take it but try to hide it. Still others put it on some "miscellaneous" line they find somewhere on the return.

Usually, the best course of action is to put the item exactly where you think it belongs IF you had all the information, and if there is some guesswork involved, the tax laws make allowances for dealing with that. For example: Your business loss from your small corporation is not well documented, or you are not sure if money you transferred to that corporation should be considered a "business bad debt" or "non-business bad debt" (ordinary or capital loss). There are very common "gray" areas where the tax laws are simply not clear. Where they are clear, the FACTS may be fuzzy.

Reporting the loss (in the example above) as an ordinary loss is certainly permissible if you have a reasonable basis for taking that position (on the facts and the law) and act in good faith. To lessen the chances of a penalty if the IRS disallows the loss, you should do as much factual and legal research as you can to document the loss (or other item in question) and put that on paper for your file.

Also consider filing Form 8275 with your return. This is a disclosure form for items as to which the tax treatment is not clear. (Yes, the IRS has an official form for gray areas.) That form asks some specific questions and then provides space for an explanation of the item. The IRS officially takes the position that filing Form 8275 does NOT increase the chance of an audit. But if the return is selected anyway, the form does allow the agent to focus on the issue where he/she might not have picked it up otherwise.

And, the big advantage of Form 8275 is that it is insurance against the "substantial understatement" of tax penalty. Moreover, you can argue against other proposed penalties, such as negligence, by holding out the form to the agent as an example of how you tried to do the right thing.

Not all gray issues require this form. Most items on Schedule C and Schedule A, and other common deductions as well, are automatically "disclosed" just by reporting them accurately on the required forms.

So consider a little "official confession" on some items when preparing your tax returns for this year.

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