An Uncompromising Approach
I spent a summer in law school managing the caseload for the school’s Low Income Taxpayer Clinic. I had advisor oversight, but since most of the clients had very similar issues with very similar options as far as providing assistance, it was mostly a matter of gathering documentation on the clients’ current finances.
When I stepped in, every single one of the clients was in the process of proving qualification for an offer in compromise. The nature of this arrangement is a concession that there is a tax obligation but an impossibility of paying it in full. The idea is to come up with some number that the client can feasibly pay, regardless of the initial obligation.
With one of the clients, something seemed off. His supposed obligation was based on an inordinate amount of capital gains based for someone whose active income did not align with having that sort of investment base. My first thought was maybe he just hit the penny stock lottery and got in early on a Google or Amazon or something to that effect. Upon reviewing his transaction history, that wasn’t the case.
Here’s what the clinic missed: the client was flipping the same stocks repeatedly, trying to time the market. He was not very good at it, for what it’s worth. Because of the way he went about his amateur daytrading, he was triggering something called the wash sale rule. The rule prevents investors from recognizing a loss without actually altering their investment position. Losses can only be used to offset gains, so the idea works something like this. Investor buys stock A for 50, sells at 100. For the capital gains on stock A, the investor is going to be on the hook for taxes. Investor has an idea, though - they bought stock B at 60 and now it’s down to 10. They don’t want to just take the loss because they think the stock is going to recover, at least somewhat, so they sell at 10 and immediately buy back at 10. The investor hasn’t really taken a loss on stock B, but there is a recognition event that would ordinarily enable them to offset the capital gains on stock A. The wash sale rule prevents this practice by prohibiting investors from recognizing losses when they repurchase the same stock within 30 days.
The client had hundreds - maybe even thousands - of transactions involving the same dozen or so stocks. Every gain was being reported as taxable by the web broker. The losses were not recognized. It took forever to spreadsheet these myriad transactions and figure out what the client actually gained or lost. It felt like dumping a bottle of water into a river and trying to bottle the same exact water way downstream, since the number of shares bought and sold at any given time varied. In the end, I was able to show that he lost money that year. I spoke to an IRS agent who, upon examining the real figures, agreed that the spirit of the rule was not implicated by the client’s behavior, and they re-assessed the obligation.
By doing a little more digging, we went from negotiating an offer in compromise to celebrating a refund. So what’s the lesson? Experience isn’t necessarily a bad thing, but, based in large part on this early lesson, it is my opinion that a lawyer should begin every case as if negotiating is not an option. Criminal law experience teaches that trials often end in plea bargains - that doesn’t make it a good starting point. Low Income Taxpayer Clinic experience revealed that clients almost always ended up arranging offers in compromise, but anticipating that arrival created a bad habit that could have been enormously detrimental to the client, if not for a hunch from a student who didn’t know any better.
