Consequences of not filing go beyond the nonfiling penalty.

• Author: Missakian, Vrezhui Aibarian

Recently, the Tax Court denied a taxpayer a deduction for a claimed theft loss because, even if he could prove that the loss had occurred, he had not filed a tax return for the year of loss and as a result did not make a proper election to itemize deductions (Murray, T.C. Memo. 2012-213). The Tax Court's opinion illustrates that not filing a return on time can have results other than a nonfiling penalty.

In Murray, the taxpayer received a direct distribution from an inherited IRA in 2006. In 2010, the IRS prepared a substitute return for 2006 on the basis of information provided by third parties. The IRS issued Murray a notice of deficiency. Murray challenged the IRS's determination in Tax Court, where among other things, he claimed he was entitled to a theft-loss deduction of $30,000. The IRS contended that even if the alleged theft loss occurred, Murray was not entitled to a theft-loss deduction because he had not filed a federal income tax return for 2006.

The Tax Court noted that under Sec. 165(c)(3), an itemized deduction is allowed for a theft loss, but under Sec. 63(e)(1), a taxpayer must elect to itemize deductions. Sec. 63(e)(2) requires a taxpayer to file a return to elect to itemize deductions. Citing its earlier decision in Jahn, T.C. Memo 2008-141, the Tax Court found that if the IRS prepares a substitute return because the taxpayer did not file one, then the taxpayer cannot claim itemized deductions.

Often, when there is no filing requirement, tax practitioners advise clients not to file a tax return. In light of these cases, one should consider advising clients to file a tax return for all tax years even if there is no filing requirement because, once an election is made to either itemize deductions or claim the standard deduction, a taxpayer may change the election on an amended return as prescribed under Regs. Sec. 1.63-1(a). If a return is not required but one is filed, the tax practitioner needs to make sure that it is a valid return. In Cabirac, 120 T.C. 163 (2003), aff'd, No. 03-3157 (3d Cir. 2004), the Tax Court held that the Forms 1040 and 1040A the taxpayer had filed showing only zeros for amounts to compute tax liability were not valid returns for federal income tax purposes under Sec. 6651(a)(1) because the taxpayer "did not make an honest and reasonable attempt to supply the information required by the Internal Revenue...