Although poor Lawrence Wickersham dies between trial and judgment, his faithful wife (and part-time dancehall operator) Mary J. carries on, in Lawrence L. Wickersham, Deceased, and Mary J. Wickersham, 2011 T.C. Mem. 78, filed 7/28/11. All their property was jointly titled and they filed jointly, so no need for administrators or executors, at least for tax purposes.

The Wickersham holdings included mixed-use residential/commercial property in Iowa, a towing business in Iowa, and the dancehall in Nebraska (Utter Place, which doesn’t figure in the computation of tax liability, but matters when deciding whether the residential property in Iowa qualifies for Section 121 treatment).

In the year at issue, the Wickershams sold their home and business (on the same property) and granted a permanent easement to Polk  County to expand the road that ran past the property.

Judge Kroupa parses the transactions. On the business side, the equipment and the wrecker get ordinary income treatment (Sections 1231 and 1245 raise their heads; recapture of depreciation trumps everything else). Judge Kroupa buys the Wickershams’ basis allocation for the land and buildings, not IRS’s, as the geography of the land (which IRS argued), goes for the Wickershams’ analysis. But the basis information the Wickershams had as to the building was inadequate to establish the IRS’s figure was wrong. And of course the commercial building portion of the property gets Section 1250 treatment; more ordinary income. The basis allocation also goes for allocating the gain on the sale of the road-widening easement to Polk County.

Now for the tough question: Does Dancehall Mary get the Section 121 half-million-dollar exclusion for the residential portion?

In the first place, Lawrence and Dancehall Mary fibbed about two tax years during the five years preceding the residential sale. They filed Nebraska income tax returns, claiming residence there. Lawrence and Dancehall Mary’s lawyers, including no less than James Monroe, tried to get Judge Kroupa to disregard the erroneous addresses, but Judge Kroupa didn’t buy it: those returns were signed under penalty of perjury. Dancehall Mary also went to Nebraska monthly to run parties at Utter Place. She even swore she was a Nebraska resident to get and keep the liquor license for Utter Place, without which the dancehall would be utterly worthless (sorry, guys).

On the other hand, poor Lawrence had all his medical treatments for throat cancer, and his hernia operation, in Iowa. He and Dancehall Mary entertained their six children and twenty-two grandchildren in Iowa, the vast majority of whom lived but a few miles from Lawrence and Dancehall Mary. Their professionals were all Iowa-based, their banking and credit card statements were sent to Iowa, all but one of their numerous motor vehicles were Iowa-registered, and they claimed Iowa homestead tax exemptions. Finally, they bought a home a few miles down the road to replace the one they’d sold.

Lawrence and Dancehall Mary were “cavalier”, to use Judge Kroupa’s word, about their primary residence. However, in a “close call”, again to use Judge Kroupa’s phrase, the Iowa residence fit the Section 121 parameters with a wee bit of squeezing. So Dancehall Mary gets the half-million exclusion as to the aliquot portion of the easement sale and the residential property sale.

Finally, Dancehall Mary escapes the negligence penalty. She provided all the information she had to, and relied in good faith upon, a woefully overmatched EA, who prepared the return  for the year at issue.

Said Judge Kroupa:  “Petitioners hired Ms. …, an enrolled agent, at the recommendation of their longtime attorney. Her firm prepares approximately a thousand income tax returns each year. Petitioners’ return was the most complex that she had ever prepared. Despite this fact, she failed to inform petitioners she was unsure. Ms. … further testified that the IRS audited fewer than 25 of the returns she prepared in 22 years, and changes were required on only two returns after audits. Petitioners’ return was one. Ms. … paid a $1,000 return preparer penalty for errors in petitioners’ return …. This was the only time she had ever been assessed such a penalty. We find that Ms. … had sufficient expertise to justify petitioners’ reliance.” 2011 T.C. Mem. 78, at p. 26. [Name omitted to spare embarrassment.]

The $1,000 penalty was probably a lot more than the EA charged for preparing the return. And she probably lost a client, and suffered a lot more grief than the whole thing was worth.

Recovered from the New York State Bar Association Tax Section Summer Meeting, I can say that, while the sessions provided much information, the information provided was hardly the stuff of which this blog is made.

I’ve said before, I’m writing for the practitioner in the trenches, the man or woman who prepares returns, advises clients other than Fortune 500 multinationals and who has to deal with the day-to-day issues, what one might call the ” small change” of Federal income, estate and gift taxation.

If,  per contra (as those who went to expensive law schools might say), one has to advise on the capitalization of a  subsidiary of a US multinational, or deal with seven-tier partnership structures, then clearly this meeting was for you. Some of the simple cases I blogged were examined in exhaustive (and sometimes exhausting) detail by professors and partners in major law firms.

Fascinating, yes. A glimpse from the foothills at the mountaintops; or almost dreamlike,  like Mr Roberts gazing at the mighty task force from the bridge of his rustbucket supply ship, going once more from Tedium to Apathy.

But of no use to the ordinary practitioner, I fear.

There are taxes and then there are taxes.

Their Cause and Cure

Sitting in the lovely Mohonk Mountain House, awaiting the start of the New York State Bar Association Tax Section’s Summer Meeting, I am lamenting the paucity of recent meaty Tax Court decisions. The summer doldrums seem to have overtaken litigants and judges.

So I turn my attention to the recent spate of blogs and chatter about the FAQs issued by IRS anent the latest iteration of OVDI–the Overseas Voluntary Disclosure Initiative, IRS’ latest appeal to the unrepentant to confess their nonreporting and nonpayments of tax in respect of their offshore cookie jars, and come over to the side of the Lord–or at least Doug Shulman and Co.

One LinkedIn discussion, to which I contributed, speaks to the “reasonable cause for delay” discussion in FAQ 25.1. The Executive Committee of the NYSBA Tax Section is to discuss a lengthy request, to be sent in letter form, to IRS, requesting an exegisis of the latest go-round of multiple FAQs, with suggestions for clarification.

All this is laudable, of course, as, while these three abide, faith, hope and clarity, the greatest of these is still clarity. I am entirely in favor of finding out whether the lion will bite, otherwise than by sticking one’s arm in the lion’s mouth.

I was discussing these initiatives with a tax expert at a well-known accounting firm. She remarked that it was all very well that IRS was issuing fresh guidance, but hasn’t the IRS’ offshore treasure hunt been going on since 2007?  And what part of “you must tell IRS about any offshore account you have with more than $10,000 in it, and pay any tax you owe” did anyone not understand? And would not IRS do better to catch some offshore procrastinators and nail them hard, pour encourager les autres, rather than expend energies on yet another round of FAQs that no one but tax lawyers will read?

I really could not answer those questions.

But It Isn’t Where Your Tax Home Is

So learn Captain Jac Baker and Aircrew Cynthia Baker in JAC E. and CYNTHIA L. BAKER, 2011 T.C. Sum. Op. 95, filed 7/19/2011. Although this is another fact-specific “don’t quote me” Section 7463, the decision goes into the general rules for tax home, and is good CPE reading.

Captain Jac was tugmaster of the vessel Malulani and, for the years at issue, “began and ended each voyage in the Honolulu, Hawaii, port. Each tug voyage lasted approximately 3 days. On eight occasions during the years in issue, Mr. Baker either began or ended his voyage in a port other than Honolulu: five of these occasions were in neighboring islands in Hawaii and three were in the continental United States.” 2011 T.C. Sum. Op. 95, at p. 4. Captain Jac recorded his unreimbursed employment expenses in a calendar he kept.

Aircrew Cynthia flew for Delta for the years at issue, as cabin attendant, based out of JFK. She flew one to four times a month during the years in question, mostly to Europe, but kept no records of the destinations. She shared an apartment near JFK with nine other aircrew, but proffered no evidence of what she spent there.

Captain Jac and Aircrew Cynthia were married. They lived in Washington State, apparently because it was the most appealing dry land halfway between JFK and Honolulu. Each deducted their travel expenses from and to their Washington State home, claiming that was their tax home.

No, says Special Trial Judge Dean. Aircrew Cynthia’s tax home is JFK, and Captain Jac’s is Honolulu. Both were permanent employees, whose employment was of indefinite duration. Although each claimed unreimbursed employee expenses, neither filed Form 2106 for the years at issue, although they did reduce the expenses claimed by the 2% AGI “floor”.

Captain Jac and Aircrew Cynthia tried to shift burden of proof via Section 7491, but their recordkeeping doesn’t pass muster.

They based the deductions at issue on Section 162. Special Trial Judge Dean: “Section 162(a)(2) allows a taxpayer to deduct traveling expenses, including amounts expended for meals and lodging, if such expenses are: (1) Ordinary and necessary, (2) incurred while away from home, and (3) incurred in the pursuit of a trade or business. Commissioner v. Flowers, 326 U.S. 465, 470 (1946). ‘The exigencies of business rather than the personal conveniences and necessities of the traveler must be the motivating factors.’ Id. at 477.” 2011 T.C. Sum. Op. 95, at p. 10.

The fact that Captain Jac and Aircrew Cynthia are married doesn’t mean that each can’t have a tax home separate from the other. While they may be together till death do them part,  for tax purposes they can be spread across the world.

Captain Jac’s tugboating endeavors almost always started in Honolulu; only rarely did he ever start anywhere else. He had a permanent place of employment for tax purposes. Aircrew Cynthia likewise was home-ported, out of JFK, and rarely if ever flew from anywhere else.

Temporary employment (what I used to call TDY in an earlier incarnation), of limited duration and a sufficient distance from one’s tax home, might allow the deduction of unreimbursed employee expenses for travel. Not here. They were permanently based elsewhere than Washington State, and their personal preferences decided where they made their permanent residence.

However, Captain Jac and Aircrew Cynthia get a bye. They used the same CPA for all the years at issue, and for years before (I somehow doubt they will use him or her for subsequent years). Special Trial Judge Dean concluded: “…considering the totality of the facts and circumstances, we are satisfied that petitioners, who used the same C.P.A. for the years in issue that they had used for several prior years, acted in good faith and come within the reasonable cause exception of section 6664(c)(1). Accordingly, we hold that petitioners are not liable for the section 6662(a) accuracy-related penalties for the years in issue.” 2011 T.C. Sum Op. 95, at pp. 21-22.

But You’re Not a Pro If Gambling  Isn’t Your Full-Time Job

 So learns Randy L. Moore, in 2011 T.C. Mem. 173, filed 7/18/11. Randy delivered food and worked as a traveling x-ray technician. But he spent his every spare moment at the casino, working the slots. He claimed he was a professional gambler, filed Schedule C so claiming, but his expenses were $40K and his winnings only $25K. He claimed a $15K loss against his x-ray wages.

Everyone agrees that gambling losses can be offset against gambling winnings, but any other gambling expense can only be deducted by professional gamblers. Likewise, non-professionals offset their losses against winnings via the Other Income line on Form 1040 for winnings, and on Schedule A for losses. Schedule C is for pros only.

IRS first raised the issue of Randy’s pro status at the answer stage of the proceedings, so IRS had Rule 142(a)(1) burden of proof. IRS claimed that Randy never replied to the answer, so their allegation of his non-professionalism must be deemed admitted under Rule 37.

No need to go there, says Judge Morrison; the trial record is sufficient to show that Randy is an amateur without any deemed admissions. Even though having the burden of proof, IRS discharges it easily.

Randy kept no records. His winnings were established by W-2Gs from two casinos.  Judge Morrison said: “Moore said that he called the IRS in 2004 to ask how to keep track of his gambling losses and that the IRS told him he could use bank statements. Moore claimed to have kept bank statements as records of his gambling transactions, but he did not present any bank statements as evidence.” 2011 T.C. Mem. 173, footnote 3, at pp. 3-4.

Judge Morrison went on: “Other documents from the two casinos purportedly have more data on Moore’s gambling activities, but we do not find the documents comprehensible or reliable.” 2011 T.C. Mem. 173, footnote 4, at p. 4.

Randy never studied gambling in a systematic way (he said he “read a couple books” about gambling, but aside from showing ignorance of the partitive genitive, that was insufficient to show professionalism). He never made a profit gambling, and his gambling certainly afforded him personal pleasure. The greatest part of his income came from his work as a rambling x-ray technician. In fact, he adjusted his gambling time around his x-raying gigs.

Randy apparently (because he never cited it by name) relied on “Commissioner v. Groetzinger, 480 U.S. 23 (1987), which he said supported the notion that he was a professional gambler because he gambled ‘full time’. But Moore’s situation differs from that of the taxpayer in Groetzinger…. The taxpayer in Groetzinger gambled 60 to 80 hours a week for 48 weeks during the year at issue and had no other employment.” 2011 T.C. Mem. 173, at p. 12. Randy was rambling around x-raying 40 hours per week during the year at issue.

So Randy falls foul of Regulation Section 1.6662-4(d)(3)(ii), which provides that an authority is not relevant if materially distinguishable on its facts. Randy was negligent, and if the Rule 155 recomputation shows substantial underpayment, Randy gets the 20% penalty. PS- Randy also left out almost $8900 of wages on his return.

So Randy may have been a rambler, but he wasn’t enough of a gambler to qualify as a pro.

Or, Drafting the Credit Shelter Trust

 Hints for drafters of credit shelter trusts (those designed to remove all non-taxable assets from an estate and pass them on to the heirs) are always useful, and some good ones can be found in Estate of Ann R. Chancellor, 2011 T.C. Mem. 172, filed 7/14/11.

Ann’s husband Lester predeceased her, creating through his will a trust wherein he placed all non-taxable assets, to the maximum amount permitted by law (the so-called unified credit). Judge Thornton takes up the story: “Under the terms of the trust as stated in the will, during decedent’s lifetime the cotrustees were authorized to apportion trust income among decedent, Mr. Chancellor’s children, and Mr. Chancellor’s grandchildren (the beneficiaries) ‘in accordance with their respective needs.’ The cotrustees were also given the right and power to invade the corpus of the trust and to use such part thereof and if necessary, all of it, for the necessary maintenance, education, health care, sustenance, welfare or other appropriate expenditures needed by * * * [Mr. Chancellor’s] wife and the other beneficiaries of this trust taking into consideration the standard of living to which they are accustomed and any income available to them from other sources.’” 2011 T.C. Mem. 172, at p. 2.

Ann’s 706 didn’t mention the trust assets. IRS said she had a general power of appointment over the trust corpus, so they should have been included, and assessed a deficiency.

No question that this is a power of appointment, as Ann could have directed the trust corpus to herself or the kids and grandkids. But the Section 2041(b)(1)(A) exception saves a general power if it is “limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent”.

So we have a two-part test:  “ascertainable standard”,  and “relating to health, education, support or maintenance”.

Lester’s estate plan passes both tests. First, IRS concedes that the “taking into consideration the standard of living to which * * * [the will beneficiaries] are accustomed” satisfies the ascertainable standard test. “Accustomed standard of living” has gotten around the Section 2041(b) slalom for years.

Now for the “relating to the health, education, support, or maintenance” test. IRS says the “welfare or other appropriate expenditures” language flunks the test–too broad. Not so, says Judge Thornton: “maintenance and sustenance” are not restricted to the bare necessities of life. And the “welfare or other appropriate expenditures” language is limited by “taking into consideration the standard of living to which they are accustomed”.

So Ann’s estate is off the hook. And drafters of credit shelter trusts have another phrase for their form files.

Or, If You Mail It, You Have to Nail It

The mailing dates, that is. Proving mailing dates is a critical matter for the IRS. Where most mailing requirements specify certified mail, this is (or should be) a non-issue, as the USPS issues date-stamped receipts and makes on-line tracking easily accessible.

But not in the Section 7623(b) “whistleblower” situation; Congress did not specify how IRS gives notice of determination of a whistleblower claim. This case comes from the time when IRS used ordinary mail. But there was no mailing log kept or PS3817 proof of mailing obtained in the case of Kenneth William Kasper, 137 T.C. 4, filed 7/12/2011.

Kenneth William caught a corporation and its CEO playing games with overtime and the payroll taxes arising therefrom. He filed Form 211, Application for Award for Original Information, a/k/a Whistleblower. Three months later, he got an acknowledgement letter from IRS, stating his claim was bifurcated, one claim being against the corporation, the other against the CEO. IRS claimed they denied both claims three months after that, with a boilerplate letter in each case, asserting that the real reason for denial was confidential under the tax laws, but giving the usual laundry list of possible bases for denial: “(1) The application provided insufficient information; (2) the information provided did not result in the recovery of taxes, penalties, or fines; or (3) the Internal Revenue Service (IRS) already had the information provided or such information was available in public records.” 137 T.C. 4 at p. 4.

In the words of the old song, “it was clear as mud but it covered the ground”.  Only Kenneth William claimed he never got either letter. Kenneth William wrote the IRS eleven months after the alleged denial letters had been mailed, stating the corporation had settled with IRS   and when was he getting his? Oh no, said IRS, we told you a year ago you were out of luck.

Kenneth William immediately petitioned Tax Court. IRS said no jurisdiction, you’re too late, and anyway we never made a determination within the meaning of Section 7623 (those letters aren’t a determination), so if you’re not too late you’re premature.

Wrong on both counts, says Judge Haines. First, the denial letters are determinations. See Cooper, 136 T.C. 30, filed 6/20/11, and see my blogpost “The Whistleblower Blows It”, 6/20/11. I’m following Cooper, says Judge Haines. IRS said “no” to Kenneth William; and that is a determination, at least as to his CEO claim.

Next, as to mailing of the determinations, Kenneth William’s petition is timely as to the CEO, and premature as to the corporation, as IRS can’t prove they mailed either the corporation or the CEO determination to Kenneth William at a time which would make his petition untimely. When Kenneth William wrote IRS asking for his share of the take from the corporation, his letter referenced the CEO claim number, and IRS sent him a copy of the CEO denial letter, not the corporation denial letter. He claims he never got the corporation denial letter.

Judge Haines now scrutinizes the IRS’ whistleblower notification procedures. “During the time relevant to this case, the standard practice within the Whistleblower Office was to prepare a denial letter and scan it into e-Trak, the Whistleblower Office’s computer database. Thereafter, history notes were written or typed, dated, and then entered into e-Trak as an investigation history report. A copy of the denial letter was placed in a paper file. “Standard mailing procedures for denial letters required that the original denial letter be placed by a clerk in an envelope addressed to the whistleblower claimant at his or her last known address and deposited in the Whistleblower Office’s outgoing mail. At the end of each day, a clerk took the outgoing mail to the facilities mailroom, where mail was picked up daily for delivery by the U.S. Postal Service. None of the letters were sent by certified or registered mail, and a mailing log was not kept. “The e-Trak system and the investigation history reports indicate that the Whistleblower Office’s standard procedures were followed in petitioner’s case. Moreover, the denial letters were addressed to petitioner at his last known address and were not returned to the Whistleblower Office by the U.S. Postal Service as undeliverable.” 137 T.C. 4, at pp. 5-6.

Unlike the lien and levy notice provision of Section 6330(d), with its certified mail language, Section 7623(b) doesn’t say how notice of determination must be given. The then current IRS manual was unclear, although the later version, inapplicable to Kenneth William, required certified mailing.

Judge Haines states the IRS argument: “The Government is generally entitled to a rebuttable presumption of delivery upon presentation of evidence of proper mailing. Although the Whistleblower Office did not have a certified mailing requirement at the time the denial letters were issued, respondent [IRS] argues there is a strong inference of delivery when it is shown that the Whistleblower Office complied with its internal procedures for mailing of the denial letters in the regular course of its operations.  A strong inference must arise from more than unsupported conclusory statements of an individual based on his assumption of how mail was handled in the normal course of business in his office. “Respondent argues that the standard operating procedures within the Whistleblower Office were followed to prove that the denial letters were mailed. The Whistleblower Office’s e-trak (sic) system was described. The e-Trak system is a computer record which indicates that a denial letter was sent but does not confirm where it was sent, to whom it was sent, or whether it was a part of the Whistleblower Office’s outgoing mail. Nor was there a mailing log.” 137 T.C. 4, at pp. 12-13. (Citations omitted).

These “unsupported conclusory statements” came from the declaration of one Bradley DeBerg, at the time the chief of the IRS whistleblower office in Ogden, UT, in support of IRS’ motion to dismiss.

Judge Haines gives Mr. DeBerg and IRS short shrift. “Although evidence of standard practice will be afforded appropriate weight as the circumstances of each case require, we cannot find that compliance with standard practices within the Whistleblower Office, standing alone,  permits a finding that the denial letters in question were mailed to petitioner…. The date a determination is mailed is of critical importance to establish our jurisdiction to review a taxpayer’s case. We will hold we do not have jurisdiction when a taxpayer does not meet the 30-day requirement. And as we have emphasized in cases involving our jurisdiction: ‘In this setting, we must require * * * [the Commissioner] to prove by direct evidence the date and fact of mailing the notice to a taxpayer.’ Magazine v. Commissioner, 89 T.C. 321, 326 (1987).” 137 T.C. 4, at p. 14.

So sorry, IRS, Kenneth William’s CEO petition is timely, because you never provided direct evidence that you denied anything until you replied to his inquiry as to the CEO claim and he promptly petitioned. And as to his corporation claim, you still haven’t told him anything, so he can’t petition until you do.

Takeaway- If taxpayers need good records, so does IRS.

Or, You Must Follow the Form

This lesson comes the hard way for Mickel and Mary Briscoe, in 2011 T.C. Mem. 165, filed 7/11/11. Mickel and ex-wife Nedra had a son, J.B., then they divorced. The divorce decree gave Nedra sole custody of J.B., but awarded her child support. Mickel paid; Nedra asked for more. The Louisiana Court gave it to her, but decreed that Mickel would get the dependency exemption. Mickel paid the increased amount.

Mickel and current wife Mary filed their 1040 for the year in issue and attached the second decree, which Nedra had signed but which did not contain Nedra’s SSAN or specify for what years Mickel would get the exemption.  Mickel and Mary claimed J.B. as a dependent, but so did Nedra, who either forgot about the decree or didn’t care. Neither Nedra nor Mickel and Mary attached Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, to their respective returns.

To be a dependent, one must be a qualifying child or qualifying relative. J.B. isn’t Mickel’s qualifying child because he didn’t live more than half the year with Mickel. Nor he is Mickel’s qualifying relative. See Section 152(d)(1)(A)- (D). Judge Vasquez said: “The two pertinent requirements are that the taxpayer must provide over one-half of the individual’s support for the taxable year and the individual must not be a qualifying child of the taxpayer or of any other taxpayer for the taxable year. Sec. 152(d)(1)(C) and (D).

“Mr. Briscoe did not substantiate the amount of J.B.’s support from all sources…. Mr. Briscoe also did not establish that J.B. was not a qualifying child of any other taxpayer….” 2011 T.C. Mem. 165, at pp. 3-4.

However, there is a savings clause,  Section 152(e)(1) and (2). Judge Vasquez unpacks the clause: “A child will be treated as the noncustodial parent’s qualifying child or qualifying relative if five requirements are met. See sec. 152(e)(1) and (2). The relevant requirements here are that the custodial parent sign a written declaration, in such manner and form as the Secretary may prescribe, that the custodial parent will not claim the child as a dependent and that the noncustodial parent attach that declaration to the noncustodial parent’s return for the taxable year. Sec. 152(e)(2)(A) and (B).

“The Internal Revenue Service issued Form 8332 in order to standardize the written declaration required by section 152(e). See, e.g., Chamberlain v. Commissioner, T.C. Memo. 2007-178. Form 8332 requires a taxpayer to furnish: (1) The name of the child; (2) the name and Social Security number of the noncustodial parent claiming the dependency exemption deduction; (3) the Social Security number of the custodial parent; (4) the signature of the custodial parent; (5) the date of the custodial parent’s signature; and (6) the year(s) for which the claims were released. See Miller v. Commissioner, 114 T.C. 184, 190 (2000), affd. on another ground sub nom. Lovejoy v. Commissioner, 293 F.3d 1208 (10th Cir. 2002). Although taxpayers are not required to use Form 8332, any other written declaration executed by the custodial parent must conform to the substance of Form 8332. See id. at 189. The general instructions for Form 8332 state that a divorce decree may be attached to the Form 1040 instead of Form 8332 if the decree states all of the items listed above, specifically the years for which the claim is released and the custodial parent’s Social Security number. Section 152(e) allows a noncustodial parent to claim the dependency exemption deduction only when that parent attaches a valid Form 8332 or its equivalent to a Federal income tax return for the taxable year for which he or she claims the dependency exemption deduction. See Paulson v. Commissioner, T.C. Memo. 1996-560.” [Footnotes omitted.]  2011 T.C. Mem. 165, at pp. 5-6.

Mickel attached the divorce decree, but it didn’t specify the years for which Mickel was to utilize the exemption, nor did it state Nedra’s SSAN.  So no exemption, and no Child Tax Credit, even though Mickel did support J.B.

Judge Vasquez sees how hard this hits Mickel and Mary: “We are not unsympathetic to petitioners’ position. We also realize that the statutory requirements may seem to work harsh results to taxpayers, such as Mr. Briscoe, who are current in their child support obligations and who are entitled to claim the dependency exemption deductions or child tax credits under the terms of a child support order. However, we are bound by the statute as written and the accompanying regulations when consistent therewith.” [Citations omitted.] 2011 T.C. Mem. 165, at pp. 7-8.

Takeaway for family lawyers: make sure your decrees allocate exemptions and credits specifically, and follow the Form 8332 six-part release tests. Judge Vasquez said five, but I count six.

To Get your Section 475 Trader Benefits

That’s the story in Richard Kay, Jr., 2011 T.C. Mem. 159, filed 7/6/11. Richard owned and operated a ball bearing business, but he claimed as well to be a day trader. So he took the mark-to-market year-end Section 475(f) election for all years at issue. That means he could take losses based on last-day-of-year prices even if he didn’t dispose of the stock.  And traders can take paper losses against ordinary income without limit, unlike investors who are limited to the $3000 capital loss limitations.

But Judge Cohen disposes of Richard’s trader status thus: one who buys and sells securities is either a dealer, a trader, or an investor. No one says Richard is a dealer. Richard says “trader”, IRS says “investor”.

A trader is one who buys and sells for his/her own account as a trade or business; an investor likewise buys and sells for his/her own account, but is not engaged in a trade or business. So the question is the one Tosca asked Scarpia: “Quando?” “How much?”

How much trading activity did Richard actually engage in, while also running the ball bearing business?

Not enough, says Judge Cohen: “In determining whether a taxpayer is a trader, nonexclusive factors to consider are: (1) The taxpayer’s intent, (2) the nature of the income to be derived from the activity, and (3) the frequency, extent, and regularity of the taxpayer’s securities transactions. Purvis v. Commissioner, 530 F.2d 1332, 1334 (9th Cir. 1976), affg. T.C. Memo. 1974-164. For a taxpayer to be a trader, the trading activity must be substantial, which means “‘frequent, regular, and continuous enough to constitute a trade or business’”. Ball v. Commissioner, T.C. Memo. 2000-245 (quoting Hart v. Commissioner, T.C. Memo. 1997-11). A taxpayer’s activities constitute a trade or business where both of the following requirements are met: (1) The taxpayer’s trading is substantial, and (2) the taxpayer seeks to catch the swings in the daily market movements and to profit from these short-term changes rather than to profit from the long-term holding of investments. King v. Commissioner, supra at 458-459; Mayer v. Commissioner, T.C. Memo. 1994-209.” 2011 T.C. Mem, 159, at pp. 7-8.

Over the three years at issue, Richard made fewer than a thousand trades. While he traded in big numbers, the amount of money involved is not dispositive. Richard actually traded on just 29 percent, 7 percent, and 8 percent, respectively, of the possible trading days in each year at issue. Moreover, his trading wasn’t in-and-out, the kind of quick-flip of a trader looking to make profits on a series of trades. He held most stocks for more than a day, unlike the trader who does not let the sun set on his/her portfolio.

And most of Richard’s income came from, and most of his time was spent on, the ball bearings, not the stock market.

In short,  Richard is an investor, not a trader.

Takeaway- As the lottery slogan says, “ya gotta be in it to win it.”

 No, Not a Misprint – The Day of the IRA

Judge Wherry pitches a double-header today, coming off the July 4 layoff, with Ronald V. and Donna-Kay Swanson, 2011 T.C. Mem. 156, filed 7/5/11, and Robert K. and Joan L. Paschall, 2011 T.C. 2, also filed 7/5/11.

The facts in the two cases scarcely differ in any material respect. Both Messrs. Paschall and Swanson are high-priced engineers with major corporations, at or near retirement. Both had traditional IRAs, either self-started or rollovers from 401(k)s. Both faced heavy-duty income taxes on MRDs or earlier withdrawals, and both had heard about converting to Roths. The bad news, even if one could meet the $100K or less MAGI and could convert without limit at that time, was that one would have to pay income tax on whatever portion of the IRA being converted exceeded one’s basis (and basis was basically contributed post-tax dollars; but one couldn’t contribute post-tax dollars if one was a participant in a qualified plan, and both were). What to do?

Enter Jim Patton, financial adviser. He counseled both Messrs. Paschall and Swanson to talk to A. Blair (“Smokey”) Stover, then a partner at Grant Thornton, at the time the fifth largest accounting firm in the country. Smokey had the sorcerer’s stone for converting taxable IRAs into non-taxable Roths, without paying income tax in between. For a mere $120K, payable out of one’s IRA, Smokey would work his magic, and Grant Thornton would defend and indemnify Messrs. Swanson and Paschall from and against interest and penalties.

Sounds too good to be true? It was. Smokey bit the dust in US v. Stover, 731 F. Supp. 2nd 887 (USDC W. Dist. Mo., St. Joseph Div., 2010), wherein the IRS got a permanent injunction against Smokey’s shennanigans. And Judge Wherry takes judicial notice of Smokey’s crash-and-burn.

What Smokey did was create a pair of shell corporations for each taxpayer, rolled their traditional IRAs into new IRAs in each shell, paid the traditionals into new Roths, merged the shells, and gave taxpayers a “tax-free” distribution out of the “new” Roths. There was no business purpose for the three-card monte game.

Judge Wherry unpacks the transaction, and then disposes of Paschalls’ statute of limitations argument. Paschall filed their 1040s timely, but never filed Form 5329 for any year at issue, and argued that the 5329 was just an addition to the 1040. To demolish this argument, Judge Wherry cites US Supreme Court learning in Com’r v. Lane-Wells Co., 321 U.S. 219, at pp. 223-224 (1944): “[A] taxpayer does not start the statute of limitations running by filing one return when a different return is required if the return filed is insufficient to advise the Commissioner that any liability exists for the tax that should have been disclosed on the other return * * * the relevant inquiry is whether the return filed sets forth the facts establishing liability. * * *”2011 T.C. 2, at pp. 13-1

Paschall’s 1040s made no mention of Smokey’s smoke-and-mirrors IRA game, so no statute of limitations applies. Said Judge Wherry: “Upon review of Mr. Paschall’s Forms 1040, respondent was not reasonably able to discern that Mr. Paschall was potentially liable for a section 4973 excise tax. While a line on each Form 1040, i.e., line 54 for 2000, line 55 for 2001, line 58 for 2002, line 57 for 2003, line 59 for 2004, and line 60 for 2005 and 2006, states “Tax on qualified plans, including IRAs, and other tax-favored accounts. Attach 5329 if required”, Mr. Paschall left these lines blank, giving respondent no indication of his excess contribution.” 2011 T.C. 2, at p. 14.

Swanson did file 5329s, and of course was audited.

Both Swanson and Paschall, seeking to avoid penalties, claimed they relied on Smokey and Grant Thornton. But that avails them nothing, as Smokey and Grant Thornton were promoters of their tax dodge. Reliance on a promoter is not justifiable reliance.

Quoting a favorite of mine, Judge Wherry states: “Courts have repeatedly held that it is unreasonable for a taxpayer to rely on a tax adviser actively involved in planning the transaction and tainted by an inherent conflict of interest. Canal Corp. v. Commissioner, 135 T.C. 199, 218 (2010)….” 2011 T.C. 2, at pp. 23-24.

See also my posting “A Piece of the Action”, 1/9/2011. As I said then: “There are certain pressures against which the better angels of our nature often strive in vain: high on that list is the pecuniary interest of the pressured one.

“In short, tax professional: don’t do it.”