If You Do It, Do It Right
That’s the lesson Judge Foley has for Peter J. Van Wickler and Laurie E. Janak, 2011 T.C. Memo. 196, filed 8/15/11. Rip Van Wickler had just been taken to the cleaners by the outgoing Mrs. Rip, who walked away with most of Rip’s stock options from his cell tower construction business. Needing to resuscitate his bank account, Rip turned to a co-worker, who sent him to an outfit called ClassicStar.
ClassicStar claimed to have “the ultimate tax solution.” Borrow the money from us, and lease championship racehorses for breeding. You get the foal, which you can sell, or race yourself. In the meantime, you get monumental current expense write-offs, which you can carry back to recoup some tax you paid before. Sounds too good to be true, right?
Rip needed someone with a tax background to look this gift horse in the appropriate orifices. Judge Foley takes up the story: “Mr. Van Wickler believed that he could make a profit through his investment in the mare lease program. He researched ClassicStar and engaged Doug Page, a certified public accountant (CPA), to review the ClassicStar materials. Mr. Page then discussed with Mr. Van Wickler the need for further assurances that the mare lease program could withstand Internal Revenue Service (IRS) scrutiny, and, after speaking with Terry Green, Mr. Page was convinced that it could. At the time, Mr. Page believed that Mr. Green, a CPA, was independent of ClassicStar.” 2011 T.C. Mem. 196, at pp. 3-4.
CPA Page has a meeting with the ClassicStar brass, and is convinced the deal will work if Rip materially participates in the activity. In jumps Rip, borrowing the money. But of course Rip never materially participates in horse breeding.
ClassicStar has one or two real throughbreds, and the rest are quarter horses or extras from a Budwieser commercial. ClassicStar generates all manner of expense statements, no two of which are consistent. ClassicStar lists all sorts of horses being leased to Rip, no two such lists being consistent. Rip files returns, takes losses, carries them back, and IRS disallows the whole thing.
Rip is not in the trade or business of breeding horses. He doesn’t visit the horses, make contracts for breeding them, and didn’t even know which horses he had under lease at any time. But he could be in a Section 212 activity for the production of income; for that he doesn’t have to know which end of the horse is which.
Unfortunately for Rip, if you’re producing income and want deductions, the deductions “must be reasonable in amount and must bear a reasonable and proximate relation to the production or collection of taxable income”. Section 212.
Judge Foley unhorses Rip’s deductions in one sweep of the lance. “To determine whether an expense is reasonable in amount, we must first determine the amount of the expense. Neither Mr. Van Wickler, nor we, could ascertain which horses Mr. Van Wickler leased. … ClassicStar provided Mr. Van Wickler with a summary of expenses which he reported on his 2002 return. In 2004, ClassicStar provided Mr. Van Wickler with more detailed expense reports which were vastly different from the previous year’s summary. The expense reports set forth a myriad of expenses but were inconsistent and contradictory and did more to obfuscate than to clarify. We cannot conclude that the amounts paid for various services were reasonable if neither we, nor Mr. Van Wickler, know the amounts of those expenses. A deduction cannot stand on so flimsy a foundation. Luman v. Commissioner, 79 T.C. 846, 859 (1982). Even if we concluded that a portion of Mr. Van Wickler’s payments was made, pursuant to section 212, for allowable ordinary and necessary expenses, the record fails to provide a rational basis by which we could allocate deductible and nondeductible expenses. See Epp v. Commissioner, 78 T.C. 801, 806 (1982). An allocation of a portion of the payment would be “speculative, amounting to ‘unguided largesse.’” Luman v. Commissioner, supra at 859 (quoting Williams v. United States, 245 F.2d 559, 560 (5th Cir.1957)). Accordingly, Mr. Van Wickler is not entitled to deduct expenses relating to the horse breeding activity.” 2011 T.C. Mem. 196, at p. 10.
Bonnie Laurie Janak, of course, knew nothing of this, 2011 T.C. Mem. 196, at p. 8, footnote 4.
Now for our old friend Section 6662, negligence. Here Rip wins in a photo finish. Judge Foley again: “Mr. Van Wickler recognized his unfamiliarity with tax law and approached Mr. Page, a CPA, to analyze the tax aspects of the mare lease program. Mr. Page reviewed the ClassicStar materials including the tax opinions, attended a presentation with ClassicStar executives, spoke with another tax professional about the ClassicStar program, and prepared the tax returns at issue. Mr. Van Wickler lacked experience and knowledge of tax law, and sought advice from Mr. Page, who was duped by ClassicStar’s materials and representatives. We conclude that Mr. Van Wickler in good faith took reasonable efforts to assess his proper tax liability and reasonably relied on Mr. Page’s expertise. See Freytag v. Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868 (1991); sec. 1.6664-4(b)(1), Income Tax Regs.
“Accordingly, he is not liable for the section 6662(a) accuracy-related penalties.” 2011 T.C. Mem. 196, at pp. 11-12.
Footnote- Terry Green, the C.P.A. Mr. Page believed was independent of ClassicStar, pled guilty to tax fraud. The plea capped what was at the time (2009) the largest tax fraud case ever brought in the State of Oregon.