Tax Court

Your Client’s Non-Cash Donation Documentation Is Probably Missing These Critical Details

Earmark Team · February 9, 2026 ·

A married couple donated used goods worth $6,760 to charity. They filed Form 8283 with their 2019 tax return. The IRS examined the return, the case ended up in Tax Court, and the entire deduction was disallowed.

What makes this case remarkable is that neither the IRS nor the Tax Court ever claimed the donation didn’t happen. Both sides agreed the contribution was real and made to a qualifying organization. The taxpayers lost anyway.

In this episode of Tax in Action, host Jeremy Wells breaks down the Besaw v. Commissioner case to reveal what went wrong. It comes down to something every tax practitioner has seen.

“When you help people with tax returns, and you ask them to upload their documents around tax time, and you get a slew of these blank Goodwill receipts,” Wells explains, “the taxpayer’s expecting some sort of tax benefit from all that. And you’re looking at that thinking, I can’t do anything with this.”

When Good Donations Go Bad

The timeline of the Besaw case reads like a warning every tax practitioner should remember.

In 2019, the Besaws filed their joint federal income tax return claiming $6,760 in non-cash charitable contributions. They attached Form 8283, the correct form for reporting non-cash donations of $500 or more. So far, so good.

But the form was basically empty. The Besaws left out the donation dates, the fair market values of the donated property, their cost basis in that property, and the method they used to arrive at the deductible amount.

“Really, all of the important information,” Wells notes.

The IRS examined the return in 2022 and requested proof for those charitable contributions. In response, the Besaws submitted what Wells calls a “reconstructed record,” essentially taking what was on their incomplete Form 8283 and using it to piece together documentation of their contributions.

The IRS said that wasn’t good enough. They denied the deduction and sent a notice of deficiency. The case wound up in Tax Court.

Contemporaneous Is The Magic Word

The fatal flaw in the Besaw case comes down to one word that appears throughout tax law: contemporaneous.

“The word contemporaneous comes up in other places in tax law as well,” Wells explains. “If you drive to meet a client or meet a vendor, you’re supposed to keep a contemporaneous written mileage log. That means you’re supposed to keep that throughout the year. You’re not supposed to look back at the prior year and try to reconstruct that from memory.”

The same principle applies to charitable contribution records. But Section 170 gives a specific definition. Documentation must be received by the earlier of the date you file your return or the due date (including extensions).

The Besaws created their records in 2022, long after filing their 2019 return and while the IRS was already examining it. That timing made all the difference.

What makes this case really striking is that nobody disputed that the donation actually happened. “At no point did the IRS or the Tax Court claim the donation may never have happened,” Wells emphasizes. “Everyone agreed that the donation happened. The issue was whether it was properly documented.”

This flows from a principle Wells returns to often. “Deductions are a matter of legislative grace.” That phrase appears throughout Tax Court decisions. It means the deduction doesn’t come free. You can’t just say you made a contribution and expect the benefit. The law sets rules for how taxpayers claim and prove deductions. Fail to meet those requirements, and the deduction disappears, even if the donation was real.

The Four Levels of Documentation Requirements

Understanding what documentation you need depends on how much you’re donating. The rules get stricter as the amounts go up.

Level 1: Non-Cash Contributions Under $250

For donations under $250, Treasury Regulation 1.170A-13(b)(1) requires a receipt showing:

The name of the charity
A description of the property
The date and location of the contribution

This is where those blank receipts from donation drop-offs become a problem. “A lot of times those slips of paper wind up in our client portal without much more than whatever is preprinted on them by the organization, which is usually just the name of the organization and its location,” Wells observes. “There’s no other information there.”

The receipt doesn’t need to include a value—that’s the taxpayer’s job. But it must describe what the taxpayer gave.

Level 2: Non-Cash Contributions Over $250

Cross the $250 threshold, and you need a contemporaneous written acknowledgment from the organization. This must include:

A description of the property
A statement of whether any goods or services were provided in exchange, and a value or good-faith estimate of those goods or services

“This is actually where the taxpayer failed in this Tax Court case,” Wells points out, “because the charity receipts contained no descriptions of the donated items.”

Remember, the acknowledgment must be received by the earlier of the filing date or the due date, including extensions. Miss that window, and you can’t fix it later.

Level 3: Total Non-Cash Contributions Over $500

When total non-cash contributions exceed $500, you must file Form 8283. Treasury Regulation 1.170A-13(b)(3) says you need to report:

The date you acquired the property
How you acquired it (i.e., purchase, gift, or inheritance)
Your cost or basis in the property
The fair market value at the time of donation
The method used to determine the fair market value

“The taxpayer in this Tax Court case left all these blank,” Wells notes. “And that was problematic for him.”

Level 4: Single Items or Groups Over $5,000

When any single item or group of similar items exceeds $5,000, IRC Section 170(f)(11)(C) requires a qualified appraisal. The taxpayer, the charity, and the appraiser all must sign Section B of Form 8283.

Wells has seen how this plays out. “I’ve had situations where taxpayers wanted to claim a deduction in excess of $5,000, and once we explain the appraisal requirement, either they didn’t want to go through with the appraisal, or they adjusted their valuation of that contribution to an amount below $5,000.”

What You Need vs. What You File

The charity doesn’t provide valuations on receipts. “It’s up to the taxpayer to report and to calculate a fair market value of those contributed items,” Wells explains. “It’s not up to the organization to put that together.”

But descriptions must be detailed enough to identify the items and estimate value. You can’t write “trunk full of stuff.” But you don’t need to list every single piece of clothing either.

Beyond what gets filed with the return, Treasury Regulation 1.170A-13 requires taxpayers to keep:

A detailed list of donated property
Receipts showing dates, locations, and descriptions
Fair market value worksheets showing how they calculated values
Any appraisals, if required

This is what the IRS requested in 2022, and what the Besaws couldn’t produce in its original form. Form 8283 is only part of the package.

Dealing with Those Blank Goodwill Receipts

“When you see those blank Goodwill receipts pop up in your client portal, how will you address those?” Wells asks. It’s a question every practitioner faces each tax season.

When receipts say something like “household goods, used clothing $1,000,” is that enough? Based on the Besaw case and the regulations, “Probably not,” Wells says. “We need a little bit more information than that.”

When non-cash charitable contributions appear, Wells recommends asking these questions:

What exactly did you donate? Get actual descriptions, not just “clothing”
When and where did they donate? Dates and locations matter
Is there a receipt or written acknowledgment? If not, do they have their own records?
Does the record describe the property adequately? “Stuff” won’t cut it
Did they receive anything in return? This affects the deductible amount
Do total non-cash contributions exceed $500? This triggers Form 8283
Does any single item exceed $5,000? This may require an appraisal
How did they determine the value? They need an actual method

Getting Real About Fair Market Value

Treasury Regulation 1.170A-1(c)(2) defines fair market value as “the price a willing, knowledgeable buyer would pay a willing, knowledgeable seller under no compulsion.”

For clothing and household goods, this usually means thrift shop value. Wells recommends a practical test. “If you didn’t know anything about this t-shirt other than you saw it hanging on a rack in a thrift shop and you liked it, what price would you reasonably pay for that?”

One common problem is sentimental value. “Just because an item holds some sentimental value for you or your family doesn’t necessarily mean it has a higher fair market value,” Wells cautions. “Sentimental value doesn’t really translate into actual market value.”

There’s also a quality requirement. Under Section 170(f)(16), clothing and household goods must be in “at least good used condition” to qualify. Worn-out or broken items are not deductible at all.

Four Myths That Create Problems

The Besaw case debunks several common assumptions:

Myth 1: A signed receipt is enough

In reality, the receipt must describe the property and include other details.

Myth 2: You can fix missing details later

This killed the Besaws’ deduction. Documentation must be contemporaneous.

Myth 3: Fair market value is optional for small donations

Form 8283 requires fair market value for every non-cash donation over $500.

Myth 4: If the donation happened, the IRS should allow it

The Besaw case proves otherwise. Both sides agreed that the donation occurred. But the Tax Court still disallowed the deduction.

The Bottom Line

The Besaw case demonstrates that, in tax law, documentation beats facts. A legitimate charitable donation means nothing without proper contemporaneous records.

Tax practitioners must remember:

Contemporaneous means by the filing date or due date (including extensions)
Different amounts trigger different requirements
Form 8283 isn’t the whole story. Taxpayers must keep detailed records
Those blank Goodwill receipts are audit risks waiting to happen

“This Tax Court case illustrates that substantiation is everything,” Wells concludes. “It really is in a lot of areas of tax law, and especially here in terms of charitable contributions.”

The charitable deduction can be powerful, but it comes with serious technical requirements. Listen to the full episode and make sure your clients understand these rules before they drop off that next load at Goodwill, and definitely before they try to claim the deduction.

The Nine Factors That Determine Whether a Business Is Real or Just a Hobby

Earmark Team · January 28, 2026 ·

Susan Crile spent 25 years as a professional artist. In all but two of those years, she reported losses on her tax returns. When the IRS came knocking with a deficiency notice that could cost her tens of thousands of dollars, they claimed her art wasn’t a real business—just an expensive hobby.

What happened next became one of the most instructive Tax Court cases for understanding how to defend business deductions against IRS challenges.

In episode 16 of Tax in Action, host Jeremy Wells, EA, CPA, breaks down Susan Crile v. Commissioner (Tax Court Memorandum 2014-202)—a case he considers essential reading for anyone working with self-employed clients. As Jeremy explains, “If you work with small business owners, I strongly recommend reading through this opinion.”

When Your Business Becomes the IRS’s Target

The hobby loss rule creates what Jeremy calls a “heads I win, tails you lose” situation for the IRS. Here’s why it’s so devastating for small business owners.

When the IRS decides your activity is a hobby rather than a business, the tax consequences are brutal. “The income from these kinds of hobby, sport or recreational activities is still included in taxable income,” Jeremy explains. “But the reverse is not true. Those losses are not deductible.”

Think about what this means. If you’re an artist who sells $10,000 worth of paintings but spends $25,000 on studio rent, supplies, and marketing, the IRS still taxes that $10,000 as income. But if they say you’re pursuing a hobby, you can’t deduct any of that $25,000 in expenses.

Since 2018, when the Tax Cuts and Jobs Act eliminated miscellaneous itemized deductions (made permanent by later legislation), hobby expenses have been completely nondeductible. You pay tax on every dollar coming in, but can’t offset any dollars going out. The only exception is cost of goods sold (COGS), as the cost of raw materials can still reduce gross income.

The burden of proving your activity is a legitimate business falls entirely on you. Courts won’t just take your word for it. As Jeremy notes, “I can say I’m hoping to make a profit someday, but the courts look at all of the objective factors that go into how I’m operating that activity.”

Who’s at Risk (And Who’s Not)

The hobby loss rule applies to nearly every small business structure: individuals filing Schedule C, partnerships, S corporations, estates, and trusts. But C corporations are completely exempt.

Jeremy points to Amazon as a perfect example. “Amazon was a C corporation pretty much from the start,” he explains. The company famously took seven to eight years before turning a profit. “There was a long time there where investors were nervous that Amazon was never going to be profitable.” Yet Amazon never faced hobby loss scrutiny because C corporations don’t have to worry about this rule.

Simply forming an LLC or electing S corporation status won’t protect you. “Just registering an entity such as an LLC or just making a tax election, such as electing to be an S corporation, doesn’t necessarily guarantee that that taxpayer is not going to have to worry about the hobby loss rule,” Jeremy emphasizes.

For partnerships and S corporations, the determination happens at the entity level, not the individual partner or shareholder level. That affects how losses flow through to individual tax returns.

Susan Crile’s David vs. Goliath Battle

Susan Crile was a tenured art professor at a university when she received IRS deficiency notices in 2010. The IRS was challenging tax years 2004, 2005, and 2007 through 2009—five years where her losses ranged from about $37,000 to $63,000 annually.

The IRS made two arguments. First, they claimed her art activity wasn’t engaged in for profit. Second, they argued that even if it was a business, it should be considered part of her work as an art professor, making the expenses unreimbursed employee expenses rather than business deductions.

Crile believed this was a test case. In an interview after the decision, she said she felt the IRS was exploring “the art industry as a whole to see how far it could go in terms of auditing artists.” Whether that’s true or not, her case established important precedents for creative professionals everywhere.

The Nine Factors That Saved Her Business

The Tax Court uses a nine-factor test from Treasury Regulation 1.183-2(b) to determine whether an activity has a profit motive. Jeremy notes that this framework actually came from earlier court cases. The courts created the test, and the Treasury later adopted it into regulations.

Here’s how each factor played out in Crile’s case:

1. The manner in which she carried on the activity

The court found Crile kept “relatively good records” of sales, galleries, and exhibitions. She worked with a bookkeeper for most years in question. But what really impressed the judge were her business decisions, like switching galleries when she realized her current venue no longer attracted buyers interested in her type of art. The judge concluded, “Petitioner’s marketing efforts demonstrate a profit objective.”

2. Her expertise and that of her advisors

The IRS tried arguing that while Crile could create art, she didn’t understand the business of selling it. The court thoroughly rejected this. The judge found she “understood the general factors that affect the pricing of art: a history of sales, gallery representation, solo exhibits, critical reviews, prestigious public accolades, and she worked diligently to achieve these credentials.” The court’s verdict? “She is, without doubt, an expert artist who understands the economics of her business.”

3. Time and effort expended

Crile spent about 30 hours per week on art during teaching periods and worked full-time creating art the rest of the year. But the court looked deeper, distinguishing between tasks necessary for any activity versus those “essential only because she was conducting a business.” Mundane business tasks like marketing, networking with collectors, and arranging shows would be unnecessary for a hobbyist.

4. Expectation that assets may appreciate

The court recognized that art is “a speculative venture where a single event, a solo show, a rave review or a museum acquisition can lead fairly suddenly to an exponential increase in the prices paid for an artist’s work.” Artists create inventory that might sit at low values for years before that breakthrough moment arrives.

5. Success in other activities

Crile had been an artist for over a decade before becoming a professor. Her academic success actually enhanced her standing with art professionals and expanded her clientele. This factor was relatively neutral in the case.

6. History of income or losses

This was Crile’s weakest point: she had only two profitable years in 25. Jeremy acknowledges “the IRS won this point.” However, the court noted that some losses might have resulted from improperly claiming personal expenses as business expenses. The 2008 financial crisis had also devastated the New York art market during several years under review. Most importantly, the court stated that “losses do not negate the petitioner’s actual and honest intent to profit from the sale of her art.”

7. Amount of occasional profits

With just two years of reported profits, this factor “weighed slightly in favor of the IRS.” But the court remained sympathetic, understanding that in the art world, one breakthrough can change everything.

8. Financial status

Crile had a salary from teaching, but she’d been an artist for over a decade before getting that job. She didn’t become an artist to shield other income from taxes. This factor was neutral.

9. Elements of personal pleasure

The court offered this memorable insight: “A level of suffering has never been made a prerequisite to deductibility.” Yes, Crile probably enjoyed creating art. But her extensive research, marketing efforts, and business operations took her activity “well beyond the realm of recreation.”

The Verdict That Protected Creative Professionals

When the court weighed all factors together, “both qualitatively and quantitatively,” the balance tipped in Crile’s favor. She had proven “an actual and honest objective of making a profit.”

The court found that her activity was indeed a business, allowing her to deduct ordinary and necessary business expenses, and any losses were deductible. As Jeremy summarizes, “Her professional conduct, demonstrated expertise, significant time commitment, and reasonable expectation of appreciation outweighed even decades of losses.”

Clearing Up the “Three-of-Five Year” Confusion

Many tax professionals misunderstand the three-of-five year rule. “I hear this misstated a lot as an activity can’t lose money for three or more years before it’s not deductible,” Jeremy says.

However, that’s not what the rule says. If an activity shows profit in any three of five consecutive years (or two of seven for horse-related activities), it creates a presumption of profit motive. This shifts the burden of proof from the taxpayer to the IRS, but it doesn’t guarantee anything.

“Even if the activity does meet that safe harbor presumption, the IRS can still determine that that activity is not engaged in for profit,” Jeremy warns. Conversely, “an activity can not have profits for more than three years and still be an activity engaged in for profit.”

Practical Lessons for Tax Professionals

Jeremy transforms Crile’s victory into actionable strategies for protecting clients:

Document everything. “Documentation and record keeping is key,” Jeremy emphasizes. “Part of the reason Crile was successful is because she had a really good documentation system of her income, expenses, and all the work she produced and her efforts to market that work.”
Understand your client’s industry. Jeremy notes how “understanding how the art industry works was key to this case.” Crile brought in expert witnesses to educate the court about art market dynamics. When you can explain why a business operates the way it does within its specific market context, losses become understandable business challenges rather than red flags.
Focus on profit motive, not profit. “Having a profit motive isn’t the same as regularly making a profit,” Jeremy clarifies. Don’t scramble to show profitability. Focus documentation efforts on proving business intent.
Get to know your clients. Jeremy urges practitioners to understand their clients’ business vision, market strategy, and operational challenges. This ensures “when they go through those periods of losses, you’ve got the ability to make a solid case for them that that activity is, in fact, still engaged in for profit.”

The Human Side of Tax Law

Jeremy finds Crile’s case particularly valuable because it shows “how technical rules and factors at play actually work out in a real life scenario.” Reading the court opinion alongside Crile’s post-case interview reveals “the human side of the story.”

The case made national headlines, with coverage suggesting it protected artists’ livelihoods by confirming their work could be businesslike. But as Jeremy notes, each case is different. “It’s entirely up to the taxpayer to conduct an activity in a professional and business-like manner to avoid the hobby loss rule.”

For tax professionals working with struggling entrepreneurs, such as artists, gig workers, or innovative startups, Crile’s case provides a masterclass in building defensible positions. The tax code, despite its complexity, can accommodate the messy reality of business development when practitioners know how to document and present their clients’ genuine business efforts.

Listen to Jeremy’s complete analysis of this landmark case in episode 16 of Tax in Action. If you work with small business owners, he strongly recommends reading the full Crile opinion to ensure your clients never face the devastating financial consequences of having their business reclassified as a hobby.

The IRS Can Hit Your Clients With Criminal Charges for Bad Bookkeeping (And Most Tax Pros Don’t Know It)

Earmark Team · January 5, 2026 ·

If you’ve ever received a shoebox full of receipts from a client or struggled with QuickBooks files where half the expenses are labeled “miscellaneous,” you know the frustration. But according to Jeremy Wells, EA, CPA, in this episode of Tax in Action, poor recordkeeping isn’t just a workflow problem. It’s a legal violation that could cost your clients thousands in penalties.

Most tax professionals treat recordkeeping like a suggestion. But it’s actually a federal requirement with serious consequences, including a 20% penalty on underpaid taxes and even potential criminal charges. Understanding these requirements can transform your practice and create new revenue opportunities.

Your clients are breaking the law (and they don’t know it)

Wells starts with a section of the tax code that most practitioners overlook. IRC Section 6001 doesn’t suggest or recommend. It requires taxpayers to “keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time provide.”

The Treasury regulations spell it out even more clearly. Taxpayers must keep “permanent books of account or records, including inventories, as are sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by such person in any return.”

“The way I read this,” Wells explains, “you as a taxpayer, in order to file a tax return, need to have permanent books and records you can rely on in order to justify and substantiate any amount of gross income, deductions, credits, or anything else that you’re putting into that return.”

Here’s what catches many people off guard: tax returns themselves don’t prove anything. In Wienke v. Commissioner (T.C. Memo 2020-143), the Tax Court established that returns are “merely statements of claims and are not considered evidence of the claims themselves.” The real evidence must come from the taxpayer’s books and records. So when your client thinks their signed tax return proves their income to a lender, they’re wrong. Without proper records backing it up, that return is just a piece of paper with numbers on it.

The penalties for inadequate recordkeeping can devastate a small business. Section 6662 imposes a 20% accuracy-related penalty on any underpayment due to negligence, which specifically includes “any failure by the taxpayer to keep adequate books and records, or to substantiate items properly.” That’s 20% on top of the taxes owed, plus interest.

But it gets worse. Section 7203 makes willful failure to keep records a criminal offense. The penalties are up to $25,000 for individuals or $100,000 for corporations, plus up to a year in prison. While Wells notes that your typical shoebox client probably won’t face jail time, the existence of criminal penalties shows how seriously the IRS takes recordkeeping requirements.

The three warning signs every practitioner must recognize

These requirements create ethical obligations for practitioners too. Circular 230, Section 10.34(d) allows you to rely on client information, but requires “reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete.”

Wells calls these the “three I’s” that should trigger immediate concern. He shares a common example: “When I ask them what their business mileage is, they’ll just tell me a flat number that has three or four zeros at the end of it. As soon as I see that information, I already know, just in my gut looking at that information, whether it appears to be incorrect, inconsistent, or incomplete.”

When you spot these red flags, you can’t just ignore them. Wells describes the uncomfortable conversation that follows when he asks for a mileage log. “Nine times out of ten, they’re going to tell me they didn’t actually keep up with one.” At that point, you face a tough choice. Do you push harder for documentation, accept questionable information, or potentially end the client relationship?

“It might be a tough decision to stop working with a taxpayer because they want to claim a certain amount of miles,” Wells acknowledges. But when clients repeatedly ignore recordkeeping requirements despite annual reminders, “at that point, we might have to reconsider the relationship.”

How good records flip the script on IRS audits

While penalties provide the stick, there’s also a powerful carrot for maintaining proper records. Wells reveals how good recordkeeping can completely change the dynamics of an IRS dispute.

Normally, the IRS holds all the cards. The Supreme Court established in Welch v. Helvering (1933) that “the commissioner’s determinations have a presumption of correctness while the taxpayer bears the burden of proving the IRS position wrong.” Wells calls this “a tough hill to climb, especially for a taxpayer that has not kept good books and records.”

But IRC Section 7491 flips this burden. When taxpayers introduce credible evidence, comply with substantiation requirements, and maintain proper records, the burden shifts to the IRS to prove the taxpayer wrong.

“If a taxpayer shows up to an examination or an audit with good books and records,” Wells explains, “then the auditor knows that under Section 7491, now it’s on the IRS to prove the taxpayer is wrong.”

This creates “a more positive settlement climate,” according to a 2003 Tax Notes article Wells cites. Auditors become more willing to negotiate reasonable settlements rather than risk losing in court. He notes that even when a taxpayer takes a “technically incorrect position,” having good records to explain their reasoning can lead to much better outcomes.

Why the Cohan Rule won’t save your clients

Many practitioners rely on the Cohan Rule as a safety net, but Wells warns it’s been dangerously misunderstood. This 1930 court decision allows taxpayers to deduct “a reasonable estimate of the amount of a verifiable trade or business expense if the exact figure is unavailable.”

“I’ve heard, between bad tax advice on social media and some practitioners who haven’t really read the court case,” Wells says, people claiming “if the client doesn’t know how much, we’ll just fill in a number and appeal to the Cohan rule.” But that’s not how it works.

Courts take a harsh view of taxpayers trying to use Cohan without basis. In Barrios v. Commissioner (2023), the court stated it “bears heavily against the taxpayer who failed to more precisely substantiate the expense.” Translation: courts will slash your estimates, sometimes to zero.

Wells cites Williams v. US (1957), where the court refused to “guess” at expenses, calling relief without evidence “unguided largesse.” The message is clear: you need some reasonable basis for any estimate, not just a number that feels right.

Making matters worse, Section 274 completely blocks the Cohan Rule for certain expenses:

Travel
Entertainment
Business gifts
Listed property (especially vehicles)

For these categories, taxpayers must keep contemporaneous logs showing time, place, amount, and business purpose. Wells emphasizes how strict this is: “There have been tax court and federal court cases where the mileage log was simply thrown out and no deductions were allowed because the taxpayer attempted to recreate that log after the fact.”

Turn recordkeeping problems into profitable services

Instead of fighting poor recordkeeping every tax season, Wells outlines specific services that transform this challenge into recurring revenue.

His foundation is a “bookkeeping review service.” You’re not doing actual bookkeeping. Instead, you review the client’s records quarterly and flag issues. “We’re probably not going to look through a lot of five, ten, twenty dollar office expenses,” Wells explains. “But we might look through some expenses that are four or five, six figures.”

During these reviews, you might spot expenses that should be capitalized instead of deducted, deposits miscategorized as revenue when they’re actually loans, or aging receivables signaling cash flow problems. The key is efficiency. “They don’t take nearly as much time as actual bookkeeping does,” Wells points out.

He also strongly advocates for direct communication with clients’ bookkeepers, eliminating the game of telephone that wastes everyone’s time. Set up quarterly check-ins to discuss categorization questions, journal entries, and ownership changes before they become tax-time emergencies.

“This should not be free,” Wells stresses. “This should not be just included. You should not just start doing this out of the goodness of your heart.” Whether bundled into tax prep fees or structured as a monthly subscription, these services must generate revenue.

Some practitioners take this even further with preferred partner networks. Wells knows firm owners who refuse to prepare returns unless the books come from their vetted bookkeepers. While it sounds extreme, the benefits are clear. “They’re never going to have to worry about whether a deposit was really revenue or contribution of equity or new line of credit, because they trust the bookkeeper to have taken care of that already.”

For maximum scalability, Wells suggests creating educational resources. Use screen recording tools to solve common problems once, then share those videos with multiple clients. “Each time a client asks you a question, you know others have that same question,” he notes. This transforms repetitive education from a time drain into a reusable asset.

Listen to transform your practice

Recordkeeping isn’t optional; it’s legally required, with penalties ranging from 20% of underpaid taxes to potential criminal charges. But understanding this framework doesn’t just protect you and your clients from disasters. It opens doors to shift audit dynamics in your favor, negotiate better settlements, and create profitable advisory services.

Will you keep wrestling with shoeboxes every tax season, hoping estimates will pass muster? Or build systematic solutions that generate recurring revenue while protecting everyone involved?

Listen to the full episode to learn exactly how to implement these strategies in your practice. Because when you understand the legal framework—the requirements, the penalties, and most importantly, the opportunities—you stop just surviving busy season and start building a practice that thrives year-round.

When Life Happens During the Wrong Tax Years—A $500,000 Lesson in Timing

Earmark Team · November 12, 2025 ·

Steven and Catherine Webert’s story began like countless American dreams: newlyweds purchasing their first home in 2005, ready to build their life together. Within months, their dream became a nightmare when Catherine received a cancer diagnosis. The couple took out a line of credit against their home to pay mounting medical bills, determined to fight both the disease and the financial strain.

Then 2008 arrived with the Great Recession, making their home impossible to sell when they desperately needed funds. Forced to convert their residence to rental property from 2010 to 2015, they watched helplessly as a decade of homeownership ultimately cost them their entire $500,000 capital gains exclusion—not through poor planning or tax avoidance schemes, but through a series of life events that collided with Section 121’s unforgiving technical requirements.

In a recent episode of the Tax in Action podcast, host Jeremy Wells, EA, CPA, explained a troubling reality about one of the tax code’s most valuable benefits. The Webert v. Commissioner case (Tax Court Memorandum 2022-32) shows how easily clients can lose hundreds of thousands of dollars in tax benefits when life circumstances like health crises, economic downturns, or rental conversions collide with the rigid five-year lookback period and three-part qualification test.

For tax professionals serving clients in a housing market where median home prices hover around $400,000 and three to four million existing homes are sold nationwide each month, understanding these nuances is essential to client protection.

The Deceptively Simple Three-Part Test That Controls Massive Tax Savings

The $250,000 capital gains exclusion from Section 121 seems like a generous gift from Congress until you examine the fine print. What appears to be straightforward tax relief is really a complex web of interconnected requirements that operate within an inflexible timeframe. Missing any single element can cost clients hundreds of thousands of dollars.

Success hinges on passing three distinct but related tests:

The ownership test requires taxpayers own their principal residence for at least two of the five years immediately preceding the sale.
The use test requires they actually live in that property as their primary residence for two of those same five years—specifically, an aggregate of 24 months or 730 days within that five-year window.
The once-every-two-years rule prohibits taxpayers from claiming the exclusion if they’ve used it on another property sale within the previous 24 months.

Understanding how this time counts is crucial for practitioners. As Wells explains, the law provides flexibility in measuring these periods. “We can either measure that in terms of 24 months, or we can measure that in terms of 730 days.” This approach can make the difference in borderline cases because “short periods of absence, such as vacations or even seasonal absences, still count as periods of use of that primary residence.”

For married couples filing jointly, the rules are more nuanced but potentially more generous. While both spouses must satisfy the use test—each living in the property as their principal residence for two of the preceding five years—only one spouse needs to meet the ownership requirement. This recognition of real-world marriage dynamics, where one spouse’s name often appears on the deed while both live in the home, doubles the maximum exclusion to $500,000 for qualifying joint filers.

Proactive planning is crucial, as Wells demonstrates with an example of a retiring client. The client owned both a primary residence near their workplace and a vacation home where they planned to spend retirement. Their natural instinct was to sell the primary residence immediately upon retirement, then move into the vacation home. But when that one-bedroom third-floor condo proved unsuitable for their mobility needs, they wanted to sell it quickly.

“Luckily, they told me about their plans before they got too far into it,” Wells explains, “so I could explain to them that they would probably have an issue with the once-every-two-years rule.” The couple ultimately decided to delay their plans, holding the vacation property until they could claim the exclusion. The decision saved them a significant tax liability on substantial capital gains.

However, failing any one of the three tests destroys the entire benefit.

How Real-World Circumstances Destroy Tax Benefits

The Webert case illustrates how health crises and economic downturns can obliterate even the most well-intentioned tax planning. Catherine and Steven Webert seemed to do everything right. They owned their home for a full decade and used it as their principal residence for four years. Yet when they filed their 2015 tax return claiming the $500,000 exclusion, the IRS issued a notice of deficiency that ultimately cost them hundreds of thousands of dollars.

The couple’s problems began with circumstances beyond their control. Catherine’s cancer diagnosis forced them to tap their home’s equity for medical expenses. The 2008 housing market collapse made selling impossible when they desperately needed cash. Converting their residence to a rental property from 2010 to 2015 seemed like the only viable option, but the couple unknowingly triggered Section 121’s most unforgiving provision.

Wells explains the arithmetic: “We have to look back five years from when they sold it. So that takes us to 2010. That entire five-year period, it was a rental. They never used it as their principal residence during that five-year window.” The law’s rigid five-year lookback period means that regardless of how long they owned the property or how legitimate their reasons for renting it, the final five years before the sale determined their eligibility.

This introduces the concept of “non-qualified use”—periods when the property wasn’t used as the taxpayer’s principal residence. However, the definition contains a crucial distinction: non-qualified use “does not include any portion of the five-year period after the last date, the taxpayer or spouse used the property as the principal residence.”

This timing distinction proves critical. As Wells explains, “If the property was a principal residence and then converted to a rental and then sold, and the taxpayer never moved back into it as a principal residence, then that period of rental is not non-qualified use.” The Weberts fell into this exact scenario. They converted to rental and never returned to personal use before selling.

Had they moved back into their home for two years before selling, converting it from rental back to personal residence, they might have qualified for the exclusion. But life doesn’t always accommodate tax planning timelines. Their health situation and subsequent living arrangements made returning to the property impossible, and the result was an unexpected tax liability.

As this case demonstrates, while Section 121 provides generous benefits for qualifying taxpayers, it offers no relief for those whose life circumstances don’t align with its technical requirements. Health crises, economic downturns, and forced rental conversions often trigger the conditions that eliminate taxpayers’ eligibility for that relief.

Why Partial Exclusions Rarely Save the Day

When tax professionals first encounter the partial exclusion provisions in Section 121, they often see them as the safety net clients need when life disrupts their tax planning. The reality is far more limited and frustrating than the language suggests.

The law establishes three safe harbors:

The distance safe harbor for employment changes applies when taxpayers move at least 50 miles farther from their former residence. Importantly, “self-employment also counts as employment.”
The physician’s recommendation safe harbor covers moves recommended by a doctor “to obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury.”
The specific event safe harbor addresses unforeseen circumstances including “involuntary conversion,” “natural disaster,” “acts of war or terrorism,” “death,” job loss “that results in an inability to pay housing or living costs,” “divorce or legal separation,” and even “multiple births from the same pregnancy.”

These exceptions allow qualifying taxpayers to claim a partial exclusion calculated by multiplying their maximum exclusion amount by the ratio of their qualifying period. A taxpayer who qualifies for only 18 months could claim 75% of their maximum exclusion—potentially $375,000 for a married couple filing jointly.

But these partial exclusions only address violations of the ownership test, use test, or once-every-two-years rule. They don’t extend the five-year lookback period that proved fatal to the Weberts’ case. As Wells explains, “There is no exception to that five-year time period. Even if you qualify under one of these other exceptions, that’s only for the ownership use or once every two-year rule.”

The health exception can be particularly misleading for practitioners and clients facing medical crises. While Catherine Webert’s cancer diagnosis seems exactly like the type of health issue the exception was designed to address, the law has strict requirements. Wells notes that “a sale that’s merely beneficial to the general health or well-being of an individual does not qualify.” This distinction is important when “older taxpayers want to move to a warmer, drier climate such as the southwest, just because they might expect to have a little bit easier time. that change in climate will not qualify for the partial exclusion.”

The specific events safe harbor creates equally frustrating limitations. While multiple births qualify as an unforeseen circumstance, “just moving because you think you can get a better, higher paying job, or you think the cost of living will be less moving somewhere else doesn’t qualify. And just deciding you don’t like where you live and want to live somewhere different, that also doesn’t qualify.”

Steven Webert attempted to argue before the Tax Court that his wife’s health crisis should qualify them for partial relief. But the court disagreed. The partial exclusions apply “only if you fail to meet the ownership use and once every two-year rule, it does not extend the five-year period. The only way you get an extension there is to work in the armed forces, foreign service, or intelligence community.”

The very circumstances that most desperately require tax relief often create exactly the conditions that eliminate eligibility for that relief. The Weberts received no exclusion—partial or otherwise—from the sale of their principal residence despite compelling reasons for every choice they made.

The case underscores why proactive planning is essential, making the difference between preserving hundreds of thousands of dollars in tax benefits and watching them disappear into the government’s coffers.

Protecting Your Clients from the Section 121 Minefield

Section 121’s technical requirements apply regardless of human circumstances. Understanding these nuances is essential for client protection, particularly when dealing with the complex scenarios that increasingly define modern family finances.

Wells emphasizes the importance of timing conversations with clients before they make irreversible decisions. His retirement planning example illustrates this perfectly. Catching the client’s plans early enough to restructure their approach saved them from losing substantial tax benefits.

Determining which property qualifies as the principal residence requires analyzing multiple factors when clients own multiple homes. Wells explains that Treas. Reg. § 1.121-2(b)(2) provides guidance including “the taxpayer’s place of employment,” “where immediate family members live,” “mailing addresses for bills and correspondence,” “where is the taxpayer’s religious organizations, recreational clubs, social events,” and “what’s the address that the taxpayer uses on federal and state documents such as tax returns, driver’s licenses, automobile registrations, voter registrations.”

The ownership rules create additional planning opportunities and traps. While married couples need only one spouse to satisfy the ownership test, both must meet the use requirement, and importantly, “the usage does not have to be concurrent.” As Wells explains, “it’s entirely possible that each spouse uses it for a different two-year period out of the last five years before the sale.”

For aging clients, special provisions offer some relief. Wells notes that “taxpayers who move into assisted living might qualify as well. So a taxpayer incapable of self-care that moves into a licensed facility, such as a nursing home, may still qualify for the exclusion if they owned and used that property as a principal residence for periods aggregating at least one year during the five-year period preceding the sale.”

The depreciation recapture rules surprises many clients. Wells explains: “The exclusion does not apply to depreciation recapture. If that property is converted to a rental and then sold, even if there is some period of use there as a principal residence, we cannot use that exclusion against the depreciation recapture.” For homes with business use, “the taxpayer has to allocate the gain to the residential and the nonresidential portions of the property.” They can only exclude the gain from the residential portion.”

These provisions interact in ways that can catch even experienced practitioners off guard. Successful Section 121 planning requires understanding the rules and how they interact with clients’ broader financial and personal circumstances.

In a highly appreciated housing market, the difference between qualifying for the full exclusion and losing it entirely can determine whether clients retire comfortably or face unexpected six-figure tax bills. As Wells concludes: “It’s incredibly important that we fully understand all of the nuances of the rules when it comes to excluding the gain and sale of the home. In their life, this could be one of the most significant, if not the most significant, financial transactions that a taxpayer is involved in.”

Your Clients’ Financial Future Hangs in the Balance

The Webert case offers a sobering reminder that in tax law, good intentions and compelling circumstances can be powerless against rigid technical requirements. Catherine and Steven Webert’s decade of responsible homeownership, their legitimate health crisis, and their reasonable responses to economic hardship meant nothing when measured against Section 121’s five-year lookback period.

Tax professionals aren’t just managing technical compliance. They’re protecting what is likely the clients’ largest financial asset and most significant transaction. Listen to the full Tax in Action podcast to learn more about Section 121’s nuances. Missing its critical timing requirements can literally determine whether your clients retire comfortably or face devastating six-figure tax bills.