ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – NET OPERATING LOSSES NOT ALLOWED FOR FRAUDULENT CONDUCT

By Robert S. Schriebman

2024

Introduction

In tax law one is not allowed to profit from one’s criminal misconduct. This is especially true in a business environment. When a legitimate business has losses that exceed its income, it is generally allowed to have a “net – operating loss.” These losses may be carried back to prior tax years or carried forward to future tax years. These laws are complex, and this is not the place go into a lengthy technical explanation.

The Office of Tax Appeals (OTA) recently decided the case of S. Sadatnejad and K. Marconet; OTA Case No. 221211991, Nov. 20-24)

When does the 10-Year Collection Statute Start?

IRS § 6502(a)(1) tells us that the 10-year collection statute begins after the date of assessment of the tax.  The collection statute starts when the IRS formally records the tax deficiency in its official records.  In other words, the collection statute does not begin to run on the date the IRS receives a tax return.  Several weeks can go by before the tax debt is officially recorded.  The most effective way to determine this date is to obtain an official transcript of your account from the IRS.

The Case of Sadathnejad/Marconet

Sadatnejad (Referred to as S) reported a business loss of over $5 million in 2017. He sought a refund from the FTB of $70,000. The refund claim was denied by the FTB and affirmed by the OTA.

S was a partner in a CPA firm. One of the clients of the firm was G. S together with an outside financial advisor handled G’s investments. Turns out that S and the financial advisor embezzled over $6 million from G and placed the money in private trusts for the benefit of their children. G sued the CPA firm, and the investment advisor and S had to make restitution of over $5 million.
S tried to deduct the restitution as a business loss and tried to claim net operating loss (NOLs) deductions.

OTA Holding

For individuals, in calculating whether the taxpayer has an NOL, in a given year, and thus a loss that is able to be carried over or back to offset income in other taxable years, any nonbusiness deductions are allowed only to extent of nonbusiness income. (IRC, §172(d)(4). If the loss at issue is a non-business loss, no NOL may be used in other taxable years. An NOL can only be used if losses arise from the conduct of a trade or business. Here, the fraudulent conduct by S in embezzling over $6 million of G’s money, and having to make restitution, is not the ordinary conduct of the business of a CPA firm. No aspect of the transactions involved G’s accounting business. Being the trustee of a trust was not part of G’s activities as a CPA. Therefore, no NOL was permitted. The restitution loss is a non-business loss and does not give rise to an NOL deductible in other years.

Conclusion

In the tax law one cannot profit from criminal-level conduct. An NOL is only allowed for losses relating to the ordinary and necessary conduct of one’s legitimate business.

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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