Archive for August, 2011|Monthly archive page


In Uncategorized on 08/12/2011 at 16:58

But You Might Have Offsetting Expenses

Did Armando and Yadira make money? Yes. Did they report what they made? No, says IRS, but it doesn’t matter, says Judge Vasquez in Armando Sandoval Lua and Yadira A. Sandoval, 2011 T.C. Mem. 192, filed 8/11/11.

The issue is $19K that Sandy gave back to his independent contractor installers for extra work they did installing the satellite dishes Sandy was in the business of selling. Sandy sold the dishes and subscription services. He hired independent contractors to put in the dishes. He paid them for the base installation, but when the customer wanted extras, Sandy would split the override with the installers. Mrs. Sandy kept the books, noted the bank deposits for the sales commissions from the satellite content providers and the base charges for installation and extras, but didn’t note the overrides the installers either kept or were given by Sandy.

Sandy and Mrs. Sandy got nailed for unreported rental income and exaggerated deductions on their real estate rental operations, but that they conceded. They fought the revenue agent’s assertion they had unreported income to the extent of what they gave the installers.

Judge Vasquez explains the deal with the installers: “Future Satellite [Sandy’s d/b/a] also received compensation from its customers when the installers performed certain installation services (additional services). The installers collected the fees for the additional services from the customers upon completion of the work. If the customers paid for the additional services in cash, Future Satellite allowed the installer who performed the additional services to keep the cash (up to the amount Future Satellite compensated the installer for the job), as his compensation for services rendered. If the customers paid for the additional services by check or the installer received cash in excess of his compensation, the installer brought the checks and/or excess cash to Future Satellite’s office. Petitioners [Sandy and Mrs. Sandy] then deposited the checks and/or cash into one of their bank accounts and issued the installer a check in the amount of his or her remaining compensation.” 2011 T.C. Mem 192, at pp. 4-5 (footnotes omitted).

So while Sandy didn’t treat the installers’ overrides as income, he didn’t deduct what he gave, or let the installers keep, either. The revenue agent who audited Sandy’s and Mrs. Sandy’s return noted that Sandy confessed to not reporting as income what he had given, or the installers kept, and only took a cursory look at Sandy’s bank statements before noting unreported income.

As to unreported income, the ordinary presumption in favor of an IRS determination doesn’t hold. IRS must show taxpayer’s connection to some income-producing activity, and then the burden shifts to the taxpayer to show that all income was reported. Here Sandy definitely had income-producing activity. And Sandy didn’t report the installers’ overrides that were kept or given back.

However, the overrides that were kept or given back would have been deductible offsets against the unreported income, so “no hurt, no foul”; or as Judge Vasquez put it more elegantly: “Petitioners admit that they did not report as income the cash portion of the $19,207 that Future Satellite earned for the additional services and allowed the installers to keep as their compensation. They argue, however, that they did not deduct as compensation paid the amounts of cash the installers kept as their compensation, and therefore any increase in income should be offset by the unclaimed deduction for compensation paid. Respondent counters that petitioners cannot substantiate the exact amount of the cash the installers kept as their compensation for services rendered.” 2011 T.C. Mem. 192, at pp. 10-11.

While giving deference to the old rule that where taxpayer incurs deductible expenses in an unspecific amount, Tax Court can estimate them, bearing heavily against the taxpayer whose inexactitude is of his own making, Judge Vasquez finds that the $19K is the right offsetting amount. “Petitioners have established that the cash Future Satellite earned and allowed the installers to keep constituted the installers’ compensation for additional services rendered and therefore was an ordinary and necessary trade or business expense deductible under section 162(a)(1). Respondent is correct that petitioners cannot determine exactly how much of the $19,207 they allowed the installers to keep as their compensation for services rendered; however, based on the record petitioners have proved that they would be entitled to an offsetting deduction in the exact amount of the portion of the $19,207 kept by the installers as their compensation. Accordingly, petitioners have shown that they incurred unclaimed offsetting deductible expenses in the exact amounts of the income they failed to report and therefore owe no tax on the unreported income.” 2011 T.C.. Mem 192, at pp. 11-12. (footnotes omitted).

Oh, by the way, the footnote number 17, which I omitted, makes an interesting arithmetic error. Footnote number 17 states “We note that $19,207 is less than 1 percent of Future Satellite’s reported gross income of $995,438.” 2011 T.C. Mem 192, at p. 12.  Sorry, Judge Vasquez, it’s less than two percent. One percent is $9954.38. Do we need a Rule 155 computation here?


In Uncategorized on 08/11/2011 at 15:00

If You Stole It, You Owe Tax

That’s the lesson Judge Goeke has for William Bradley Wood and Nancy Lynn Wood, in 2011 T.C. Mem. 190, filed 8/10/11.

Woodie was general manager of a door store and had signatory power over the bank account. He was running a grocery store on the side that wasn’t doing too well, so he helped himself to nearly half a million of the door store’s dollars, to keep himself and Nancy Lynn in the style to which they were rapidly becoming accustomed, and keep the bacon and beans flowing at Woodie’s, his eponymous grocery store.

Woodie gets busted and does three years hard, plus owes the door store $200K restitution. IRS gets into the act and assesses Woodie and Nancy Lynn (she was treasurer of the grocery store and beneficiary of the lifestyle) for taxes on the stolen money, which they neither reported nor ever paid tax.

Judge Goeke takes up the story:  “Mr. Wood used the misappropriated money to cover personal expenses, pay credit card bills, and support Woodie’s.  The Woods were unable to produce at trial any books or records of Woodie’s’ finances. The Woods failed to report any of the misappropriated funds on their joint income tax returns….

“The Woods have conceded taxes and accuracy-related penalties are owed on the funds used for personal expenses and credit card bills. However, the disposition of the money put directly into the Woodie’s account remains in dispute.” 2011 T.C. Mem. 190, at p. 3.

Woodie’s attorney, who got fired between trial and judgment (I hope he got paid up front), argues that since Woodie’s the grocery store got some of the stolen loot, the grocery store owes tax on that money, not Woodie himself nor sweet Nancy Lynn.

No, says Judge Goeke. What you do with what you stole is nothing to the point. The point is, you stole. As the underwear ad used to say, what goes on after that is up to you. But you got the money, so you owe the tax, whatever you did later.

Or in legalese, “The parties dispute the proper treatment of the money Mr. Wood misappropriated from … and used in the Woodie’s business. The Woods claim Mr. Wood acted as the president of Woodie’s, not in an individual capacity, when he wrote checks from … to Woodie’s and thus the money should be counted as income to Woodie’s, not to the Woods. Respondent argues that Mr. Wood, as an employee of …, misappropriated funds and determined whether to use them for personal expenses, credit card bills, or to support Woodie’s. Therefore, respondent asserts that how the misappropriated funds were put to use is of no consequence to this matter because Mr. Wood’s control over the funds requires inclusion in the Woods’ income. We agree with respondent. The Woods are confusing how the money was used with how the money was acquired. Mr. Wood misused his position at … to misappropriate the funds and used the money in whatever manner he chose. Because he had dominion over the misappropriated funds from …, all of the misappropriated funds became part of the Woods’ gross income.” 2011 T.C. Mem. 190, at p. 4.

In a marvelous example of chutzpah, Woodie’s attorney argues that since the grocery store got the disputed monies and didn’t treat them as income on the grocery store’s income tax return, they were a contribution to capital and not taxable either to Woodie or to the grocery store. You really have to hope he got paid up front. To use the vernacular, ya gotta love Woodie’s attorney.

Of course, as aforesaid, Woodie never put any financial records from the grocery store in evidence on the trial. Judge Goeke misses a really great opportunity for an ironic blast at Woodie’s attorney, when he writes drily, “Using the stolen funds as a contribution to capital does not relieve the Woods of their responsibility to report the funds as income, and Woodie’s is not a party to this case.” 2011 T.C. Mem. 190, at p. 5.

So Woodie and sweet Nancy Lynn lose.

In short, if you got it, it’s yours, whatever you did with it later.


New Circular 230 – The New Disreputables

In Uncategorized on 08/10/2011 at 14:45

Thomas Bridgman, EA,  noted some changes that the new Circular 230,  effective July 26, 2011, makes to what constitutes “disreputable conduct”, that is, grounds for OPR discipline. These are (with citations to Circular 230):

10.51(a)(16): willful failure to electronically file returns that are required to be so filed

10.51(a)(17): willfully preparing all (or substantially all) or signing as paid preparer a return when the preparer does not possess a valid PTIN

10.51(a)(18) willfully representing a taxpayer before an IRS officer or employee unless authorized to do so by Circular 230

These seem to go to the Registered (or unregistered, as the case may be) Preparers, the latest category of persons subject to Circular 230.

Thanks, Mr Bridgman. Now let’s see how this plays out in practice–hopefully not involving anyone we know!


In Uncategorized on 08/09/2011 at 16:51

Or, If You Choose the Form, You’re Stuck With the Substance

That’s the takeaway from Judge Cohen’s dissection of Jess Miller’s corporate machinations in Jess L. Miller, 2011 T.C. Mem. 189, filed 8/9/11.

Jess had an S corp of which he was sole shareholder. In the year before the year at issue, he entered into a contract of sale with his son, to sell Sonny a majority interest. The contract set no closing date; Jess was supposed to resign as officer and director at closing (which never happened so he never did); and Sonny was supposed to pay Jess $95K, which he didn’t do either. Incidentally, Jess had amended the Certificate of Incorporation of his S corp to create a second class of stock, but although Judge Cohen mentions this, the corp is still treated as an S corp throughout.

Jess later filed a 709 claiming he gifted his son 95% of the S corp in the year before the year at issue.

In the year at issue, Jess got substantial cash distributions from the S corp, disproportionately greater to his now-minority interest, and Sonny got less than he should have gotten, given his majority interest. The S corp apparently had neither current nor accumulated E&P, so the only question was whether the distributions  Jess got exceeded Jess’ basis in his S corp stock, and therefore were taxable as long-term capital gains. Section 1368(b) controls.

Judge Cohen: “For S corporations without accumulated earnings and profits, distributions are not included in a shareholder’s gross income to the extent that they do not exceed the adjusted basis of the shareholder’s stock (but are applied to reduce basis), while any distribution amount in excess of basis is treated as gain from the sale or exchange of property. Sec. 1368(b). For purposes of section 1368(b), a distribution is taken into account on the date the corporation makes the distribution, regardless of when the distribution is treated as received by the shareholder. Sec.1.1368-1(b), Income Tax Regs.

“The parties agree that petitioner’s [Jess’] JAM stock basis was $866,795 before he transferred 95 percent of his shares to his son. On his 2002 Form 709, petitioner reported that his adjusted basis in stock transferred by gift on December 31, 2002, was $823,456. Respondent notes that in the notice of deficiency, petitioner’s adjusted basis in his remaining 5,000 shares after the transfer of JAM shares to his son was improperly calculated as $51,661 (instead of $43,339), but respondent does not argue for application of a figure other than $51,661.” 2011 T.C. Mem 189, at pp. 8-9.

Jess claimed he didn’t give Sonny the stock until the year at issue, not the prior year, but his original 709 and the stock ledger book of the S corp say otherwise. Then Jess argues that the transfer to Sonny was part gift and part sale. No, says Judge Cohen, your contract of sale says what you should have done, and you didn’t do it. And there is no sign of any payment for the stock, so no sale.

Since the distributions were certainly disproportionate, Jess argues they didn’t create a second class of stock but should be recharacterized, citing Regulation Section 1.1361-1(l)(2)(i), which provides, in part:

“Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances.”

Jess argues that the facts and circumstances test should not be applied to change the character of the distributions, but rather to change the date of transfer of the shares. Misplaced, says Judge Cohen. The facts and circumstances clearly show when the stock was transferred.

Judge Cohen again: “It is well established that ‘a transaction is to be given its tax effect in accord with what actually occurred and not in accord with what might have occurred’ and that ‘while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not’. Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148-149 (1974).” 2011 T.C. Mem. 189, at p. 10.

In short, choose the form, and you’re stuck with the substance.


In Uncategorized on 08/08/2011 at 17:03

Or, You Have to Be Current If You Want An Alternative

 So Judge Halpern reminds us in Simone’s Butterfly, 2011 T.C. Mem. 187, filed 8/8/11. Simone’s Butterfly, a D.C. corporation, ran up $50K in liabilities, interest and penalties for the years at issue, and didn’t make its 2010 estimated tax payments. Butterfly filed its returns showing tax due for those years, but paid nothing. So IRS assessed tax, and sent Butterfly the Notice of Intent to Levy.

Butterfly missed an initial phone appointment with Appeals, but later submitted an incomplete Form 433-B in support of an OIC.

Issue presented: Was Appeals’ denial “arbitrary or capricious, lacks sound basis in law, or is not justifiable in light of the facts and circumstances”? 2011 T.C. Mem. 187, at p. 9, specifically in denying Butterfly an OIC because Butterfly wasn’t current with its 2010 estimated payments?

The statute is Section 6330(c)(3)(c), which propounds this test: is the method of collection chosen by IRS (in this case, lien and levy) “no more intrusive than necessary” to collect the taxes, interest and penalties concededly due?

Yes, says Judge Halpern: “…petitioner [Butterfly] had over $50,000 of unpaid taxes for years beginning in 2003. It appears to have provided her [the Appeals officer] an incomplete Form 433-B, and it did provide her with inconsistent financial information. [Butterfly’s attorney] suggested an installment agreement, but she provided no terms. Moreover, [the Appeals officer’s] decision to preclude petitioner from entering into an installment agreement because of its failure to pay estimated taxes was based on applicable procedures contained in the Commissioner’s Internal Revenue Manual (IRM).[Footnote Omitted.] According to those procedures, in determining whether a taxpayer is eligible for an installment agreement an IRS employee must:

‘Analyze the current year’s anticipated tax liability. If it appears a taxpayer   will have a balance due at the end of the current year, the accrued liability may be included in an agreement. Compliance with filing, paying estimated taxes, and federal tax deposits must be current from the date the installment agreement begins. * * *’

“IRM pt. (Sept. 26, 2008) (emphasis added). Respondent avers, and petitioner does not deny, that petitioner made no estimated tax payments for 2010.” 2011 T.C. Mem. 187, at p. 13.

It’s not just the Manual, says Judge Halpern. Installment agreements, OIC and other alternatives to levy run the risk of pyramiding delinquencies if the taxpayer can’t come current when the alternative begins. “Estimated tax payments, intended to ensure that current taxes are paid, are a significant component of the Federal tax system, and [the Appeals officer] was entitled to rely on their absence in reaching her conclusions. See Cox v. Commissioner, 126 T.C. 237, 258 (2006), revd. on other grounds 514 F.3d 1119 (10th Cir. 2008); Schwartz v. Commissioner, T.C. Memo. 2007-155. In fact, petitioner’s circumstances illustrate one of the reasons for requiring current compliance before granting collection alternatives such as an offer-in-compromise or an installment agreement; namely, the risk of pyramiding tax liability (i.e., that failure to pay current tax liabilities might result in an increasing total tax liability notwithstanding some payment of past tax liabilities). See Orum v. Commissioner, 412 F.3d 819, 821 (7th Cir. 2005), affg. 123 T.C. 1 (2004).” 2011 T.C. Mem. 187, at p. 14.

So summary judgment for IRS.


In Uncategorized on 08/02/2011 at 17:39

Or, Documentation is the Name of the Game

 Once again Tax Court stresses the old rule: Documentation isn’t the most important thing, it’s the only thing. Thus spake Judge Wherry in James and Deborah Ledger, 2011 T.C. Mem. 183, filed 8/2/11.

Jimmy took out an endowment insurance policy in the early Seventies that paid off in the year at issue to the extent of $40K after the investment in the contract was deducted. Jimmy took out more than a dozen loans against the policy over the years, and claimed he paid tax on the proceeds each time, but introduced no evidence to show he’d ever paid any tax.

The insurance company paid off the loans at maturity of the policy via a bookkeeping entry, and sent Jimmy the net proceeds; he got the proceeds, but the 1099-R the insurer mailed him showing the $40K payout, Jimmy claims he never got. No matter, says Judge Wherry, the parties stipulated it was sent and the amount it showed, 2011 T.C. Mem. 183, at p. 3, footnote 2.

Our old friend Section 72(e) makes all insurance payouts other than annuities gross income, to the extent the payout exceeds investment in the contract (as defined in the statute). Judge Wherry lays it all out thus: “The term ‘investment in the contract’ is defined under section 72(e)(6) as ‘(A) the aggregate amount of premiums or other consideration paid for the contract before such date, minus(B) the aggregate amount received under the contract before such date, to the extent that such amount was excludable from gross income’.

“For Federal income tax purposes, loans against a life insurance contract’s cash value are treated as true loans from the insurance company to the policyholder with the policy serving as collateral. See Minnis v. Commissioner, 71 T.C. 1049, 1054(1979); Sanders v. Commissioner, T.C. Memo. 2010-279; Atwood v. Commissioner, T.C. Memo. 1999-61. Thus, using the policy’s proceeds to satisfy the loans has the same effect as paying the proceeds directly to the policyholder. See Atwood v. Commissioner, supra.” 2011 T.C. Mem. 183, at pp. 5-6.

See also my blogpost “A Dangerous Thing”, posted 4/13/11, wherein I describe how an attorney with an LL.M. in Taxation came a cropper on this principle.

Jimmy may have conflated taxes he paid on dividends on the policy with taxes he never paid on loans against the policy. “Mr. Ledger testified at trial that he had already ‘paid taxes’ on any money he took out of the policy, specifically any dividends that were issued to him. Mr. Ledger also testified at trial that he does not ‘know the difference between a dividend or calling the insurance company and say [sic], I need another $3,000 for the kids school and they sent it to me.’” 2011 T.C. Mem. 183, at p.6.

Not good enough, Jimmy, says Judge Wherry. You never proved what taxes you paid, if any. And your want of knowledge of the difference between a loan and a dividend will not help you.

Bottom line–As the old advertising slogan for the finance company said, “Never borrow money needlessly, but when you must, borrow confidently…” but keep meticulous records.


In Uncategorized on 08/01/2011 at 18:45

Or, Your Wish Is Our Remand

It was John Churchill’s wish that Appeals reconsider his reduced circumstances in fixing his RCP (Reasonable Collection Potential). John’s wife had divorced him between his Collection Due Process hearing and the determination his Rule 122 motion in Tax Court  contested. Judge Holmes grants John’s wish in John L. Churchill, 2011 T.C. Mem. 182, filed 8/1/11.

John was a California real estate agent in the boom-and-bust market of the early years of this millennium. John claimed he married Sharon halfway through the series of years at issue as a marriage of convenience, to gain access to her health insurance. In fact, John had heart attack number three while Appeals was considering his OIC, 2011 T.C. Mem. 182, at p.3.

Judge Holmes tells the story of John’s marital and tax woes: “John Churchill offered to settle thirteen years of tax debts totaling more than $250,000 for only $2,500. The Commissioner rejected this offer because it was based on his income alone, even though his bride had a good and steady income, and it’s IRS policy in community-property states to consider both spouses’ incomes even if only one has a tax debt. This made the bride unhappy, and she told Churchill that if he didn’t solve his tax problems, she would leave. He didn’t, and she did.” 2011 T.C. Memo. 182, at pp. 1-2.

John never contested liability, so no trial de novo and it’s all about abuse of discretion.

Appeals considered the bride’s income because she and John were married at the time of the hearing, and California, that famous community-property state, holds spouses liable for each other’s debts, even those contracted pre-nuptial. John attempted to argue his medical condition and health-insurance costs were not considered by Appeals, but the record shows Appeals considered whatever John brought before them.

John’s argued that the marriage was one of “convenience,” and should have been disregarded; he and bride filed separate tax returns. But Judge Holmes isn’t buying it: “Churchill claims that Schwarz’s [bride’s] assets and income should not be included because their marriage was one of convenience. The Commissioner does not distinguish among motivations for marriage: for income-tax purposes, married is married.” 2011 T.C. Mem. 182, at p. 10, footnote 5.

And an Appeals hearing is a snapshot in time. Appeals cannot abuse its discretion by not considering events that had not yet taken place at the time of the hearing.

But the intervening divorce does give Judge Holmes sufficient rope to rescue hapless John. “At one time, we thought we could consider new information where it became available after the CDP hearing–at least when it wasn’t the taxpayer’s fault that he didn’t raise the issue before. See Magana, 118 T.C. at 494 (“This case does not involve an allegation of recent, unusual illness or hardship * * * that might cause us to make an exception to the general rule set forth herein and to consider petitioner’s new hardship argument”). A few years later, however, we firmly limited our review of section 6330(c)(2) issues to those presented in the CDP hearing. See Giamelli v. Commissioner, 129 T.C. 107, 115 (2007). Accordingly, the Court cannot now update Churchill’s snapshot and make our own determination. But can we remand?” 2011 T.C. Mem. 182, at p. 11.

Yes, says Judge Holmes. First, courts can remand under their general powers to resolve disputes expeditiously. Second, remand is available where the party whose determination is being reviewed has abused its discretion. Finally, “(E)ven more compelling is that the Supreme Court has held that when there is a question of  ‘changed circumstances’ raised on appeal, well-established principles of administrative law will generally require the issue be remanded back to the agency for its consideration. INS v. Ventura, 537 U.S. 12, 14-18 (2002); see also SKF USA, Inc. v. United States, 254 F.3d 1022, 1028 (Fed. Cir. 2001) (remand generally required when subsequent events may affect the validity of the agency action). It is clear that remand doesn’t ‘encroach upon administrative functions.’ Ford Motor Co. v. NLRB, 305 U.S. 364, 374 (1939).

“We therefore hold that we do have authority to remand a CDP case for consideration of changed circumstances when remand would be helpful, necessary, or productive. This standard is satisfied in this case. This means that the answer to the question with which we began–did the Commissioner abuse his discretion in declining Churchill’s offer in compromise–is that we can’t say yet.” (footnotes omitted) 2011 T. C. Mem. 182, at pp. 13-14.

So John goes back to Appeals. His medical insurance and state of health are not for reconsideration, as John introduced no evidence of changed circumstances there.