Attorney-at-Law

Archive for June, 2011|Monthly archive page

NO “DEFINITE MAYBE”S

In Uncategorized on 06/30/2011 at 15:46

The Gift Must Be Complete

Unlike Sam Goldwyn, who invented the “definite maybe”, Tax Court is unimpressed by uncompleted gifts. And Judge Laro waves the play “incomplete” in E. Bruce and Denise A. Agness Didonato, 2011 T.C. Mem. 153, filed 6/29/11.

E. Bruce and Denise A. gave the New Jersey Green Acres Fund of Mercer County what they claimed was a $1,870,000 green acres easement, divesting themselves of development rights on property adjacent to a public park. To prove the gift, E. Bruce and Denise A. introduced a settlement agreement from a State-court lawsuit they brought against the County and the New Jersey Department of Environmental Protection (NJDEP) over an easement on the parkland, as proof of the donation, claiming it satisfied the contemporaneous acknowledgment of receipt requirements of Section 170(f)(8).

Judge Laro says it didn’t.  The effectiveness of the settlement agreement was contingent upon public hearings before the NJDEP, and various other acts, which weren’t finally completed until two years after E. Bruce and Denise A. supposedly made the gift.

E. Bruce and Denise A. then proffered a letter from the County thanking them for the donation, but it was dated two years after the tax year in which E. Bruce and Denise A. claimed they made the gift, and didn’t estimate the value of the donation.

E. Bruce and Denise A. filed a Form 8283 with their 1040, but the 8283 wasn’t signed by the appraiser whose report accompanied their 1040. Although IRS said nothing about the appraisal, Judge Laro found plenty of fault with the appraisal:  “Although respondent does not allege any defect in the appraisal…, we express concern over the validity and credibility of that appraisal. First, we observe that the appraisal includes in the value of the donated property the development rights on three parcels of property when the deed of restriction concerned development rights on only the two parcels making up the [donated] parcel.  Second, the appraisal uses market value and not fair market value as a standard of value. In that regard, the definition of market value in the appraisal embodies selective elements of fair market value but does not encompass the definition of fair market value required by sec.20.2031-1(b), Estate Tax Regs.” [citations omitted], 2011 T.C. Mem. 153, footnote 8, at p. 10. Appraisers beware!

So the letter acknowledgment, if acknowledgment it was, was not contemporaneous. And the settlement agreement could not be an acknowledgment, as there was no completed gift when the settlement agreement was signed, the contingencies enumerated therein not having yet been satisfied.

And of course neither the settlement agreement nor the letter stated that E. Bruce and Denise A. didn’t receive anything of value from the County.

Takeaway- A gift must be completed–no loose ends. And the tests of Section 170(f)(8) must be met contemporaneously with delivery of gift: description of gift and good faith estimate of value, and statement that nothing of value was paid to donor.

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NEITHER BORROWER NOR LENDER BE

In Uncategorized on 06/27/2011 at 21:22

Or, If It Doesn’t Look Like a Loan, It Isn’t

The takeaway from John C. and Margaret T. Ramig, 2011 T.C. Mem. 147, filed 6/27/11, is that, if you make a loan to a business in which you have an ownership interest, the more it looks like a loan, the better chance you have for a business bad debt deduction.

John was a lawyer turned shoe salesman. He started an on-line C Corporation shoe store in the early dot.com days, but it soon lost its footing and never made money. John made four purported loans, the remaining unpaid balance of which aggregated $29,600, to the business, none of which was ever repaid. What sinks John’s business bad debt deduction is that John never treated the loans as loans, even paying business creditors before taking any payment on the loans.

Judge Morrison lists the factors Ninth Circuit (where an appeal would lie) would consider in determining that the monies paid, 2011 T.C. Mem. 147, at p. 18. These are (i) the labels on the documents evidencing the (supposed) indebtedness, (ii) the presence or absence of a maturity date, (iii) the source of payment, (iv) the right of the (supposed) lender to enforce payment, (v) the lender’s right to participate in management, (vi) the lender’s right to collect compared to the regular corporate creditors, (vii) the parties’ intent, (viii) the adequacy of the (supposed) borrower’s capitalization, (ix) whether stockholders’ advances to the corporation are in the same proportion as their equity ownership in the corporation, (x) the payment of interest out of only “dividend money”, and (xi) the borrower’s ability to obtain loans from outside lenders.

Though there were notes from the C Corp to John, John signed only one of the four both as lender and as officer of the borrower. The other three were unsigned. Though there were maturity dates stated in the notes, the parties ignored them. Interest was never paid, and John testified he expected to be repaid if the C Corp could raise further capital from investors (which it never did). John clearly paid trade creditors ahead of the noteholder (himself).

Thin capitalization is neutral, as neither John nor IRS introduced evidence on that point.  But the outside financing availability factor weighs against John, as the C Corp clearly was unable to generate sufficient revenue to pay an arms’-length lender, and John never introduced evidence to show the C Corp could borrow from other sources. Although John’s advances were not proportional to his ownership interest, Judge Morrison gives this little weight, as he does whether John increased his right to participate in management, as no evidence was introduced on that point.

As for enforceability, it is questionable whether one can enforce an unsigned promissory note.

Bottom line–John was an equity investor, not a creditor.

My footnote-  Judge Morrison noted that John raised no other possible tax treatment with respect to the unpaid advances. How about capital loss, long or short term as the case might have been? John never asked, so Judge Morrison did not tell.

‘SUCH RAREFIED HEIGHTS OF PURE MATHEMATICS”

In Uncategorized on 06/25/2011 at 09:46

 Or, A Credible Appraisal Saves the Day

Fans of Sherlock Holmes will recognize his encomium to his nemesis, Prof. Moriarity: “Is he not the celebrated author of The Dynamics of an Asteroid, a book which ascends to such rarefied heights of pure mathematics that it is said that there was no man in the scientific press capable of criticizing it?”

I could say the same about Judge Morrison’s decision in Estate of Natale B. Giustina, Deceased, Laraway Michael Giustina, Executor, 2011 T.C.Mem. 141, filed 6/22/11. But here the object of the rarefied heights of pure mathematics is not found in outer space, but rather in a forest in Oregon. The late Nat, through a revocable trust everyone agrees should be disregarded for estate tax purposes, owned a 41.128% interest in a limited partnership; the partnership’s business was lumbering over 47,000 acres of Oregon timberland. The issue was valuing Nat’s interest at date of death. Laraway was the executor, and claimed around $12 million; IRS said $33 million.

Judge Morrison carefully unpacks the trust instrument and the limited partnership agreement. Who can break up the property, how can they break it up, and if they break it up what would a sale yield? Judge Morrison finds a sale would yield more present value dollars than continuing lumbering operations, finding the probability of the sale sufficiently high to justify a valuation taking that probability into account.

Judge Morrison also evaluates the expert appraisers’ testimony, both IRS’ and Laraway’s, and mixes and matches their methodologies and results to come in at $27 million, apparently discounting IRS’ expert’s value by 20%, and increasing Laraway’s expert’s value by 56%, ascending to the “rarefied heights of pure mathematics” that inspired Sherlock’s breathless praise.

Unhappily for Laraway, the estate is therefore in the Section 6662 substantial- understatement-because-of-estate-tax-undervaluation 20% penalty zone, as his number is more than 50% below what Judge Morrison finds.

Judge Morrison does admit that all the mathematical juggling, impressive as it is, still has a basic flaw. He quotes Repetti: “The entire valuation process is a boundless subjective inquiry: To value an asset the court has to make guesses or assumptions about the future. These inquiries require speculation about the composition of management * * *

Repetti, “Minority Discounts: The Alchemy in Estate and Gift Taxation”, 50 Tax L. Rev. 415, 445 (1995).” 2011 T.C.Mem 141, at p. 21.

The difficulty does not deter Judge Morrison.

Now Laraway is looking at $2 million plus of penalty on top of a $15 million deficiency. But help is on the way. Says Judge Morrison: “However, no penalty is imposed with respect to an underpayment if there was reasonable cause for the underpayment and the taxpayer acted in good faith. Sec. 6664(c)(1). Whether an underpayment of tax is made in good faith and due to reasonable cause will depend upon the facts and circumstances of each case. Sec. 1.6664-4(b)(1), Income Tax Regs. In determining whether a taxpayer acted reasonably and in good faith with regard to the valuation of property, factors to be considered include: (1) the methodology and assumptions underlying the appraisal; (2) the appraised value; (3) the circumstances under which the appraisal was obtained; and (4) the appraiser’s relationship to the taxpayer. Id. Although the IRS bears the burden of production under section 7491(c) that the section 6662 penalty is appropriate, the taxpayer bears the burden of proof in demonstrating reasonable cause. See Higbee v. Commissioner, 116 T.C. 438, 446-448 (2001).” 2011 T.C.Mem. 141, at p. 29.

To prepare the Form 706, Laraway hired a lawyer, who hired an asset appraisal company, which produced an appraisal. Rather than unpacking yet another appraisal, Judge Morrison finds that, although he does not agree with the appraisal company’s results and finds their methodology deficient, their methodology and result were sufficiently credible to let Laraway rely in good faith on their number. So no penalty.

Takeaway for fiduciaries- Have a third party professional choose an appraiser with decent credentials, and rely in good faith.

To my readers–I was down in Virginia at the National Society of Tax Professionals’ summer school, so I missed a day or two of postings. I’m catching up. And for any who didn’t get the word, the new Registered Preparers Office at IRS is taking over the examination functions formerly carried on by OPR at Treasury. OPR will be strictly rulemaking and enforcement. A more energetic enforcement is coming: beware!

THE WHISTLEBLOWER BLOWS IT

In Uncategorized on 06/20/2011 at 16:55

Or, No Recovery, No Reward

That’s the lesson in William Prentice Cooper, III, 136 T.C. 30, released 6/20/11. Bill was a Nashville tax lawyer representing a disgruntled trust beneficiary, in the course of which Bill turned up what he claimed was massive estate tax and GST evasion on the part of the trustor. Blowing the whistle, Bill sought Section 7623 bounty.

IRS reviewed Bill’s two Forms 211, and said “no hurt, no foul”. When Bill petitioned Tax Court, IRS claimed he was premature as there had been no “determination”, only letters from IRS saying they could find no violation of tax law. Tax Court said no, Tax Court has jurisdiction and the IRS letters constitute a sufficient “determination” to trigger a review of Bill’s claims.

Bill wanted Tax Court to hold a full-dress trial to see if there had been a violation of law. No, says Tax Court, we’ve not jurisdiction to do that. Besides, Bill fails to meet the threshold tests for 7623 largesse.

Here’s what Judge Kroupa says:  “Generally, an individual who provides information to the Secretary that leads the Secretary to proceed with an administrative or judicial action shall receive an award equal to a percentage of the collected proceeds. Sec. 7623(b)(1). Thus, a whistleblower award is dependent upon both the initiation of an administrative or judicial action and collection of tax proceeds. (emphasis in original)

“Petitioner seeks to litigate whether any Federal estate tax or gift tax is due from the taxpayer. Our jurisdiction in a whistleblower action is different from our jurisdiction to review a deficiency determination. We have jurisdiction in a deficiency action to redetermine whether there is any income, estate or gift tax due. See sec. 6214(a). In a whistleblower action, however, we have jurisdiction only with respect to the Commissioner’s award determination. See sec. 7623(b). Our jurisdiction under section 7623(b) does not contemplate that we redetermine the tax liability of the taxpayer.” 136 T.C. 30, at p.6.

Tax Court cannot second guess the IRS. IRS seems to have processed the applications properly and found no basis to proceed.  No action, no collection, no reward.

LIFE AFTER FEDERAL TAX CONSEQUENCES

In Uncategorized on 06/17/2011 at 16:33

Or, There are Other Considerations Besides Federal Taxes – Ask Alice

 Federal tax practitioners inhabit so wide a box, packed full of so many  interesting puzzles and conundra, that it’s hard to think that anything else matters. But it may have in Alice Schneider, 2011 T.C. Sum. Op. 72, filed 6/16/11. It’s another Section 7463 “don’t quote me”, but the point here definitely isn’t the Federal tax issue.

This case involved the first go-round of the First-Time Homebuyer Credit, the $7500 payback-over-fifteen-years credit that was supposed to end the housing meltdown. Alice’s Mom willed her New York City cooperative apartment to Alice and Alice’s six siblings in equal shares.  Alice wanted the apartment, so she bought out her siblings for a total of $235,000, getting a credit against the purchase price of one-seventh of her distributive share of Mom’s estate.

The contract of sale ran from her big sister, as executrix of Mom’s estate, as seller, to Alice, as purchaser. Alice claimed the $7500 credit on her 2008 return and filed Form 5405, but IRS disallowed the credit because of the related-party purchase. Alice bought from Mom’s estate, of which she was a beneficiary, and as Section 36 read at the time, a deal between executor of an estate and a beneficiary of that estate was ineligible for the credit.

Alice argued that she really bought from her six siblings, because they got the money, despite the terms of the contract of sale.

No good, Judge Jacobs said: “Although petitioner’s siblings ultimately received the proceeds from the sale of the co-op, petitioner’s acquisition of the co-op was cast as a purchase from her mother’s estate; and it is a well-accepted tax principle that a taxpayer is bound by the form given to the transaction. See Don E. Williams Co. v. Commissioner, 429 U.S. 569, 579-580 (1977); Senra v. Commissioner, T.C. Memo. 2009-79. In this regard, the Supreme Court has held that a taxpayer must accept the tax consequences of his or her choice and may not enjoy the benefit of some other route he or she might have chosen to follow but did not.” 2011 T.C. Sum. Op 72, at p. 6.

Alice did what all disappointed taxpayers,  sellers and purchasers do–blamed her attorney: “According to petitioner, the attorney who represented both her and the estate advised her that it would be ‘cleaner’ to purchase the co-op from the estate rather than from her siblings”. 2011 T.C. Sum. Op. 72, footnote 1 at page 2.

But look at the practicalities. This is not a sale where it’s simply “do the deed”, take it to the register or clerk, pay a few bucks and done. Doing it via the siblings meant first, a transfer from Mom’s estate to the seven children. In a New York City cooperative, this means preparing a lengthy application to the Board of Directors and undergoing rather more scrutiny than a sexting Member of Congress, and paying healthy processing fees to the managing agent, Board of Directors, transfer agent, attorneys, title agents and assorted hangers-on.

Then, even though Sister Alice was just screened as one of the Seven, you may be sure she will be screened again, and have to pay a fresh set of processing fees to the entire cast of characters from Act One, when she buys from the Six.

New York State Transfer Tax will apply to both transfers, at the rate of four dollars per thousand, requiring, in this case, an additional payment of $940. New York City Transfer Tax would also be applicable to the “extra” transfer, at the rate of 1% of gross consideration (here FMV as measured by the contract of sale) plus $100 filing fee, in this case $2360. Thus, nearly half of the $7500 credit would be consumed by the second-sale transfer taxes necessitated by chasing after the $7500 credit. The additional fees of the managing agent, attorneys, et al would easily take care of a large part of the rest.

And as Tax Court pointed out: “Although referred to as a ‘credit’, for the tax year in question (i.e., 2008) the first-time homebuyer credit is essentially a governmental, non-interest-bearing loan inasmuch as the recipient taxpayer must repay the credit over a 15-year period. Sec. 36(f).” 2011 T.C. Sum. Op. 72, footnote 3, at page 4.

So be careful of chasing for a Federal tax benefit–it may cost more than it’s worth.

IT MIGHT BE A RIP-OFF BUT IT ISN’T A THEFT

In Uncategorized on 06/16/2011 at 16:41

Thus Tax Court rejects the proposed installment agreement of Oscar C. and Aranka M. Hawaii, 2011 T.C. Mem. 134, filed 6/15/11.

Oscar wanted a Section 6159(a) streamlined installment agreement, and claimed his tax balance due was under $25,000 (thus entitling him to a streamline). IRS said no, disallowing a $100,000 theft loss Oscar claimed, based on his purchase of some stock that he claims was a fraud. Oscar took one-third of his retirement portfolio, and gave it to a fellow parishioner who was promoting a corporation called ProCore Group, Inc.

Apparently the only business ProCore had was grabbing money, according to Oscar. Oscar had to hire counsel and threaten suit to get his stock certificates. The certificate showed he owned 3,333,333 restricted and unregistered shares in the company. Oscar spent the next four years trying to recover his investment, hiring counsel and complaining to State governmental authorities. Nothing happened.

Tax Court denies Oscar’s theft loss. Oscar claims Section 165(a) casualty loss for theft. But when was there a loss, if any? Judge Ruwe states the rule:  “Generally, a theft loss is treated as sustained during the taxable year in which the taxpayer discovers it. Sec. 165(a), (e). However, even after a theft loss is discovered, if a claim for reimbursement exists during the year of the loss with respect to which there is a reasonable prospect of recovery, then a theft loss is treated as “sustained” only when it can be ascertained with reasonable certainty whether such reimbursement for the loss will be obtained.” 2011 T.C. Mem. 134, at p. 9.

State law determines what is theft. Taxpayers need only prove by a preponderance of evidence that the loss was in fact caused by theft. A criminal conviction is not necessary. But Oscar produced no evidence to show that, under the relevant State law (Ohio, in Oscar’s case), there was in fact a theft loss, or even that his ProCore stock was worthless.

Judge Ruwe said: “At trial petitioner implied throughout his testimony that his investment was stolen but provided no specific evidence in support of that conclusion. The record indicates that petitioners made a $100,000 payment for an investment in ProCore, in exchange for which they received 3,333,333 shares of stock in the company.[Footnote omitted.] There is no evidence that the 3,333,333 shares of stock ProCore issued are not valid and legitimate shares of stock. Petitioner testified that the shares had been accepted by Charles Schwab and that he was never notified that the shares were in any way irregular or deficient. Petitioners provided no evidence, other than petitioner’s testimony, to establish that the 3,333,333 shares of ProCore stock were valueless in 2005 or that they ever became valueless.” 2011 T.C. Mem. 134, at pp.  11-12.

In short, Oscar may have made a bad deal. Or maybe not. But if he was ripped off, he didn’t prove he wuz robbed.

NAME AND NUMBER

In Uncategorized on 06/09/2011 at 22:27

Or, What Counts and What Doesn’t

Two Tax Court cases filed 6/9/11, and each is interesting.

As the old saying goes, a short horse is soon brushed, so let’s start with the number–zip code number. In Nahmi Lee, 136 T.C. Mem. 129, it’s all about the statutory notice of deficiency, the “90-day letter.” IRS sent a 90-day letter to Nahmi’s last known address, but with the wrong zip code, another to a former business address now occupied by an unrelated party (who subsequently sent the notice on to Nahmi’s mother, who, Tax Court finds, “is elderly, is not fluent in English, does not sort her own mail, and frequently is away from her residence at the 46th Street location, working in upstate New York. “ 136 T.C. Mem. 129, at p. 4), and still another to a New Jersey address, concededly not the last known address of Nahmi. Nahmi claims the notice was late, and her petition was timely filed.

No, says Judge Jacobs. The zipcode error is immaterial; if the notice is sent to the last known address, receipt by taxpayer is immaterial. Judge Jacobs puts it this way: “This Court has long held that an inconsequential error in the address used in mailing a notice of deficiency does not render the notice invalid. [citations omitted] An error in the address used in mailing a notice of deficiency is inconsequential where the error is so minor that it would not prevent delivery of the notice.[citations omitted].” 136 T.C. Mem. 129, at p. 6. And the Pickering case, Pickering v. Commissioner, T.C. Memo. 1998-142, disposed of the wrong zipcode issue once and for all.

So Nahmi loses, no jurisdiction under Section 6213(a) (90 days means 90 days from mailing, period), petition dismissed.

Takeaway: any mail from IRS gets top-shelf priority.

Now for the name: Retief Goosen, 136 T.C. 27. Goose is a pro golfer, non-resident alien (South African national residing in the UK for years in question), apparently a big enough noise in the pro golfing world to garner endorsements from the likes of Rolex, Acushnet, Izod and Upper Deck, among others. The issue is Goose’s allocation of endorsement revenue between personal services and royalty income, and secondarily between effectively connected US income and non-effectively connected US income.

Goose entered into employment deals with his management firm, who promo’d him while funneling his income from the pro tour and endorsements into Liechenstein and Channel Islands entities, to keep his non-UK earnings from the UK tax man. The UK tax man agreed.

Goose’s success on the course gained him endorsements of two kinds: wearing or using sponsor’s materials in tournaments (product placement) and non-tournament endorsements. In addition, Goose had to make some personal appearances, test equipment, and generally keep his name clean–no sex, drugs or rock ‘n’ roll.

The issue was the allocation of endorsement money. Goose allocated his tournament US earnings as a fraction of his total world-wide earnings. IRS allocated all US tournament earnings to the US, not just the fraction that represented the US share of Goose’s world-wide earnings. IRS and Goose agreed that non-tournament earnings were royalties, not personal service income, but IRS said 25% was US income and Goose said 10%.

No one disputed that Goose was in a trade or business (TOB) when he played golf for money in the US.

Tax Court looked at what Goose and his sponsors agreed to. In some sponsorship deals, Goose had to play in a certain number of tournaments, with bonuses if he won, and keep clean. He also allowed sponsors to use his name and likeness to advertise their wares. Advertisers testified that Goose’s cool, professional image and his upstanding citizen persona were valuable, aside from his substantial golfing prowess.

So the sponsors needed both Goose’s playing skills and his image. Tax Court agrees with Goose, and splits the US tournament money 50-50 between personal services and royalty income, stressing that this is our old pal facts-and-circumstances at work.

Turning to sourcing, royalty income for intangibles is sourced where the intangible is used. Goose tries the UK deal, 25% UK and 75% elsewhere. Tax Court rejects this. Tax Court looks at sales: trading cards and video games with Goose’s stamp on them are mostly sold in the US, so they’re sourced in the US.

On-course and Rolex present a different problem. Goose is a world-wide brand. While Goose’s US wins give him great creds, Goose musters enough evidence to convince Tax Court to refuse to source all Goose’s on-course and Rolex money to the US, and ends up splitting it 50-50.

Now for effective connection. Goose never had a fixed place of business in the US, so he is only taxed on his US-sourced income effectively connected to his US TOB.

Tax Court summarizes the basics: “In the case of U.S.-source income that is effectively connected with a U.S. trade or business, a nonresident alien will be subject to the graduated tax rates applicable to U.S. residents. In the case of U.S.- source income that is not effectively connected with a U.S. trade or business and consists of rents, dividends, royalties or other fixed or determinable annual or periodic income, the nonresident-alien will be subject to a flat 30-percent withholding tax.” 136 T.C. 27, at pp. 32-33.

Any money related to Goose’s participation in golf tournaments is effectively connected. But off-course, where there was no contractual obligation for Goose to show up, play or do anything, is not effectively connected.

Goose claimed the 12/31/1975 US-UK tax treaty, preventing uncoordinated or double taxation of the contracting parties’ nationals protects whatever part of his US-taxed income was received (and presumably taxed) in the UK. But Goose didn’t prove what was actually received in the UK, because his Liechtenstein and Channel Islands fronts got the money, and what they sent to the UK wasn’t categorized as royalty, personal services, or anything else. So Goose bogeyed that hole.

Takeaway- Facts-and-circumstances prevail again. Goose’s witnesses helped his cause. And Tax Court again plays strict rules of golf.

LOVE (OR AT LEAST TAXES) WITH THE PROPER STRANGER

In Uncategorized on 06/08/2011 at 17:59

I may be showing my age, but I remember the Natalie Wood, Steve McQueen and Edie Adams 1963 movie so entitled.  The “proper stranger” problem arose for Seven W. Enterprises, Inc., 136 T.C. 26, filed 6/7/11, when they rehired their former Vice-President for Taxation after he had resigned and freelanced while attending law school.

The VP had been a CPA with Deloitte. Seven W. hired him and made him VP for Taxation, in which capacity he served for ten years, until he went back to school full-time, at which point he consulted with Seven W.  per separate agreement but was no longer on the payroll.

While freelancing, VP prepared one year’s returns for Seven W. Thereafter, he came back to Seven W. as VP for Taxation and prepared the next several years’ returns, signing each of them on behalf of Seven W. as VP of Taxation.

But for several years, both when freelance and in-house, VP erroneously concluded that interest on a $4 million-plus promissory note came from within Seven W.’s group of companies, and wasn’t taxable as personal holding company income. Wrong, says IRS and Tax Court; it was from a proper stranger and thus taxable as personal holding company income, so deficiency, interest and accuracy (substantial understatement) penalties rained down on Seven W.

Seeking to duck the Section 6662 understatement penalties, Seven W. raises the standard Section 6664(c)(1) flag: “We relied on our expert preparer.”

OK, says Judge Foley, but only for the freelance year,  not for the years that VP was back in the fold as VP for Taxation. He begins with the basics:  “The determination of whether a taxpayer acted with reasonable cause and in good faith depends upon the facts and circumstances, including the taxpayer’s efforts to assess his or her proper tax liability; experience, knowledge, and education; and reliance on the advice of a professional tax advisor. Sec. 1.6664-4(b)(1), Income Tax Regs.” 136 T.C. 26, at pp. 7-8.

IRS  initially claims the freelance year wasn’t truly freelance, because VP did the same work whether in-house or out-of-house. Wrong, says Judge Foley; there was a real consulting agreement, VP had resigned, the consulting agreement provided that Seven W. did not supervise VP, and Seven W. relied in good faith, so no penalty for the freelance year.

Not so for the in-house years. Aside from what Judge Foley described as Seven W.’s “myriad of mistakes… the result of confusion, inattention to detail, or pure laziness, but we are convinced that petitioners and [VP] failed to exercise the requisite due care.” 136 T.C. 26, at p. 9, VP wasn’t independent.

VP was no longer an independent freelancer, so Seven W.’s case runs hard aground on Reg. 1.6664-4(c)(2): “advice” is “any communication… setting forth the analysis or conclusion of a person, other than the taxpayer”. (Emphasis added.). VP wasn’t a person other than the taxpayer. Corporations can only act through their officers, VP was an officer, and he signed the returns he prepared during the in-house years as VP for Taxation.

Seven W.’s reliance on the foundation excise tax regulations and the REIT regulations to bring VP into the ambit of the house counsel’s opinions exceptions doesn’t fly, because those regulations deal with willful conduct, and also require a “reasoned written opinion”, which VP never supplied.

So Seven W. gets hit for the understatement penalties for the years that VP was under their roof. I have no idea whether VP will remain under their roof after this decision.

Takeaway–Love with the proper stranger. If you want to rely on an expert, find one from outside your shop.

The $250 Misunderstanding

In Uncategorized on 06/03/2011 at 18:15

Recordkeeping for Charitable Services

Tax Court carefully reviews the requirements for deducting the value of expenses incurred in rendering services to a Section 501(c)(3) charitable organization in Jan Elizabeth Van Dusen 136 T.C. 25, released 6/2/11. This is a useful review, well worth the time it takes to read the 42 pages of Judge Morrison’s opinion.

Jan was an attorney who took care of feral (that is, wild) cats. She worked with several California charities, principally Fix Our Ferals, which took in wild cats, neutered them, and released them back into the wild. This was a Publication 78 organization, and Judge Morrison took judicial notice of that fact.

The sole issue remaining from the deficiency was a $12K charitable deduction Jan took for her unreimbursed out-of-pocket expenses incidental to her rendering services. Some of these out-of-pockets were expenditures of less than $250, and some were $250 or greater. Of course, the value of her time and labor are not deductible.

As to Jan’s recordkeeping, Judge Morrison said: “Van Dusen introduced the following evidence as proof of her foster-cat expenses: check copies, bank account statements, credit card statements, a Thornhill Pet Hospital client account history, a Costco purchase history, Pacific Gas & Electric invoices, a Waste Management payment history (for garbage removal), and an East Bay Municipal Utility District billing history (for water). All the data in the documents was recorded contemporaneously….Van Dusen states that she initially had more substantial records of her foster-cat expenses, namely itemized receipts, but that her tax preparer, Cary Cheng, told her they were unnecessary for preparing her original return. Those records have since disappeared. Van Dusen compiled the documents she introduced at trial by searching through other records and requesting records from third parties. “ 136 T.C. 25, at p. 11 [footnote omitted].

The “check copies” referred to were photocopies of the carbon copies from Jan’s checkbook; apparently she used checks that made carbon copies as a check was written, and these were acceptable to Tax Court as substitutes for canceled checks or copies thereof.

IRS first contended that Jan was an independent cat rescuer and not affiliated with Fix Our Ferals, which itself was a loose organization of volunteers. Judge Morrison rejected IRS’ position, saying:  “In determining whether a taxpayer has provided services to a particular organization, courts consider the strength of the taxpayer’s affiliation with the organization, the organization’s ability to initiate or request services from the taxpayer, the organization’s supervision over the taxpayer’s work, and the taxpayer’s accountability to the organization.” 136 T.C. 25, at p. 15.  Jan passed the test.

To the extent any of Jan’s claimed deductible expenses served both charitable and personal functions, they were disallowed.

Because of the extensive services Jan rendered, Judge Morrison carefully examined the claimed expenses and apportioned them on a percentage basis between personal items and charitable items. Then Judge Morrison discusses the requisite substantiation requirements.

The money contribution regulations (1.170A-13(a)) apply to nonreimbursed out-of-pocket expenditures. The non-monetary contribution rules impose irrelevant requirements, and most unreimbursed expenses are paid with money. The regulations require that the taxpayer maintain, for monetary contributions less than $250, “(I)n the absence of a canceled check or receipt from the donee charitable organization, other reliable written records showing the name of the donee, the date of the contribution, and the amount of the contribution.” Regulation 1.170A-13(a)(1)(iii).

Tax Court found Jan substantially complied with the requirements, even though her compliance was not strict compliance. The key here is that strict compliance with the Regulation is not required. See Bond v. Commissioner, 100 T.C. 32 (1993).

However, because Jan didn’t get contemporaneous written acknowledgments from Fix Our Ferals when she incurred the $250 and over expenses, she gets none of those deductions.

Note for preparers-Save every receipt for unreimbursed charitable contributions.

Note for volunteers- If you have a large unreimbursed expense, get a statement from the charity describing the services provided, whether or not the donee organization provides any goods or services in consideration, in whole or in part, for the unreimbursed expenditures; and a description and good faith estimate of the value of any goods or services provided by the donee organization.

THE CHECK’S THE THING

In Uncategorized on 06/01/2011 at 18:27

Or, When is a Return Filed?

That’s what Tax Court had to determine in the case of Martin R. Dingman, 2011 T.C. Mem. 116, filed 6/1/11. Martin had plenty of problems. The C.I.D. nailed him for criminal non-filing, and he pled guilty.

But while the investigation was ongoing, Martin had his accountants prepare returns for the missing years, and Martin’s attorneys handed these returns to the CID. Somehow, never explained by IRS, IRS’ records show checks in the amounts Martin’s attorney tendered to C.I.D. received at a date which would prove Martin right and the statute expired by the date of the later assessment of the Section 6651(a) fraud penalty that IRS was belatedly trying to collect via this levy.

IRS claimed Martin had signed a statute of limitations extension agreement, but never produced it. Likewise, IRS admitted they never served notices of deficiency (90-day letters) (although IRS first claimed 90-day letters were sent). So Tax Court treats this CDP case as one where Martin had no opportunity to contest the assessment, and gives it de novo treatment.

The only question before Tax Court: did giving C.I.D. the returns (and checks in payment of at least some of the tax due) start the clock running on the three-year statute of limitations?

Judge Marvel wades through Regulations, General Counsel Advices, Notices and a bushel-basketful of cases for 37 pages to conclude that, because IRS’ records, incomplete and unexplained as some of them might be, indicate that the checks were paid and therefore the returns (erroneously styled “amended returns”) were in fact received by the critical date, handing them to C.I.D. did effect “filing.”

Burden of pleading and proof rest upon Martin. Even after IRS goes forward with contrary evidence, burden of persuasion still rests on Martin. Judge Marvel credits Martin’s testimony about delivery and expressly rejects IRS’ transcripts, which contain unexplained codes and remarks.

But Martin still faces the “meticulous compliance by the taxpayer with all named conditions,” hurdle from  Winnett v. Commissioner, 96 T.C. 802, 807-808 (1991) (quoting Lucas v. Pilliod Lumber Co., 281 U.S. 245, 249(1930)). In plain English, must apply strict rules of golf, no gimmes, no Mulligans.

Martin clears the hurdle, helped by the IRS Reorganization of 1998. The filing protocols had changed, but not Section 6091 (the filing section) or the Regulations, when Martin’s attorney gave C.I.D. the checks and returns. IRS had earlier issued a Notice trying to clarify the confused situation, but the Notice wasn’t effective as of the date Martin’s attorney handed C.I.D. the returns.

IRS issued Regulations embodying the Notice provisions the next year, and claimed they were mere clarifications and therefore were retroactive. Wrong, says Judge Marvel. There is nothing in the Regulations or anywhere else that say they are to be given retroactivity.

So Judge Marvel goes on to say: “The record does not establish exactly how or when petitioner’s counsel delivered the package of returns and checks to the CID. In the normal case, such a gap in the record would dictate that the taxpayer, who has the burden of proof on the limitations issue, must lose. This is not the normal case, however. [Editorial comment–Couldn’t agree more, Judge!]

“Although the record is not clear regarding the details of the delivery of the tax return package to the IRS, the record clearly establishes two important facts: (1) The tax return package was delivered to the IRS no later than February 19, 2003, and (2) the package was received by an IRS office that had the authority to process its contents. We know these facts because the income tax transcripts in the record confirm that the checks to pay petitioner’s 1996 and 1997 tax liabilities as reported on petitioner’s 1996 and 1997 returns were processed, deposited, and ultimately credited to petitioner’s 1996 and 1997 accounts on February 19, 2003.” 2011 T.C. Mem. 116, at p. 26.

IRS called no witnesses and produced no evidence except the discredited transcripts. IRS only argued a long line of cases holding delivery to a Revenue Agent is not filing within Section 6091. Judge Marvel disposes of this argument summarily: “None of the cases respondent cites involved an attempt by the taxpayer to file executed original returns with payments, and none of the cases involved evidence that the payments made with the returns were actually processed by the IRS and credited to the taxpayer’s account.” 2011 T.C. Memo. 116, at p. 30 [emphasis added].

Finally, and most importantly, in the words of Tax Court: “Moreover, we have held that if a taxpayer submits a return to a person who is not authorized to accept the return for filing and the return is then forwarded to the correct IRS office, the period of limitations commences when the office designated to receive the return actually receives it. See Winnett v.Commissioner, 96 T.C. at 808 (holding that for purposes of determining the beginning of the period of limitations a return is deemed filed when it is received by the ‘revenue office designated to receive such return’); Allnutt v. Commissioner, T.C. Memo. 2002-311 (returns deemed filed when the District Director’s office stamped them received).” 2011 T.C. Mem. 116, at page 35.

Martin wins, statute of limitations expired, no Section 6651 penalty.

Takeaway? Make sure you file per Regulations and Instructions for the form in question, get receipts, and save all copies and canceled checks.