Maybe not, in the case of Thomas and Monica L. Kleber, 2011 T.C. Mem. 233, filed 9/28/11. The issue is when was Farmer Monica relieved of her obligations for past due rent, interest and administrative fee she owed to the U. S. Navy.

Farmer Monica leased land at the NAS Lemoore, CA for agricultural purposes. The lease term was four calendar years, but during Year Two Farmer Monica quit paying rent and at year-end told the Navy she was giving up the farm.

Manning battle stations, the Navy sent Farmer Monica notices of default, lease cancellation notice, demands for payment, and, when these availed not, sent the matter to the Defense Finance and Accounting Services (DFAS), the bill collector, to get the Navy its money. DFAS sent a collection letter and then did nothing for almost a year-and-a-half, then bucked the problem to Treasury Cross-Service Program, who might have been cross but performed no service, and took three years to send the file back to DFAS, stating the bill was uncollectable. A year later, DFAS writes off the debt, and still another year later Farmer Monica gets a 1099-C, Cancellation of Debt, showing $263K of cancelled debt.

Farmer Monica and Husband Tom file their return timely but don’t mention the $263K. Surprise, surprise, 90-day letter follows.

Farmer Monica and Husband Tom petition, saying “Wrong year, amount claimed is wrong, anyway debt cancelled years ago, statute has run, anchors aweigh.”

Take it away, Judge Haines:  “If an information return, such as a Form 1099-C, serves as the basis for the determination of a deficiency, section 6201(d) may apply to shift the burden of production to the Commissioner. Section 6201(d) provides that in any court proceeding, if a taxpayer asserts a reasonable dispute with respect to the income reported on an information return and the taxpayer has fully cooperated with the Commissioner, then the Commissioner has the burden of producing reasonable and probative information in addition to the information return.” 2011 T.C. Mem. 233, at p. 5.

IRS puts in all the dunning letters from the Navy and DFAS, and a timeline showing everything that happened. Judge Haines says that’s good enough to meet the Section 6201(d) burden of production.

OK, but when was the debt actually canceled or discharged? Judge Haines again: “The moment it becomes clear that a debt will never be repaid, that debt must be viewed as having been discharged. The determination of whether discharge of indebtedness has occurred is fact specific and often turns on the subjective intent of the creditor as manifested by an objectively identifiable event.” 2011 T. C. Mem 233, at pp. 6-7. [citation omitted.]

Judge Haines goes on: “There is a rebuttable presumption that an identifiable event has occurred during a calendar year if a creditor has not received a payment on an indebtedness at any time during a testing period ending at the close of the year. Sec. 1.6050P-1(b)(2)(iv), Income Tax Regs. The testing period is a 36-month period increased by the number of calendar months during all or part of which the creditor was precluded from engaging in collection activity by a stay in bankruptcy or similar bar under State or local law.” 2011 T. C. Mem. 233, at pp. 7-8.

Of course presumptions were made to be rebutted, and this the Navy can do if it showed it “…engaged in significant, bona fide collection activity at any time during the 12-month period ending at the close of the calendar year, or if facts and circumstances existing as of January 31 of the calendar year following expiration of the 36-month period indicate that the indebtedness has not been discharged. Significant, bona fide collection activity does not include nominal or ministerial collection action, such as automated mailing.” 2011 T. C. Mem 233, at p. 8.

The documents IRS proffered show no significant collection activity–no lien, no sale of the debt, or anything that an active creditor would do. Letters aren’t enough.

The Navy was asleep on watch.  The debt was canceled long before the year for which the 1099-C was issued, the statute has run, and the ship has left. Oh, by the way, no penalty for Farmer Monica.

Takeaway: Creditors, on deck! Stand to your guns!

Or, Your Dues Include the Magazine

The National Education Association (NEA) publishes two magazines, both of which contain paid-for advertising. The costs of the magazines are included in the annual dues paid by members, and members can opt out of receiving the magazines (but with no reduction in their annual dues). NEA deducted the magazine costs from the advertising revenue, attributed no part of the members’ dues as income to offset the magazine costs (circulation income), and claimed to owe no Unrelated Business Income Tax (UBIT).

Wrong, says Judge Gustafson, in National Education Association, 137 T.C. 8, filed 9/28/11. The key regulation is section 1.512(a)-1(f)(3)(iii).

Judge Gustafson: “The issue for decision is whether NEA must allocate a portion of its members’ dues to the circulation income of those magazines. The parties agree that the outcome of this dispute depends on whether, for purposes of 26 C.F.R. section 1.512(a)-1(f)(3)(iii), Income Tax Regs., membership in NEA gave members ‘the right to receive’ NEA periodicals. If the members had a ‘right to receive’ the magazines, then: (a) a portion of the members’ dues was circulation income; (b) as a result of that income, NEA did not have a loss from circulation activity; (c) NEA’s income from advertising (an ‘unrelated’ activity subject to UBIT) was therefore not offset by any circulation losses; and (d) NEA owes tax on the advertising income. NEA concedes that if the IRS prevails on this issue, then the IRS’s computations are correct with respect to the amounts of membership dues allocable to circulation income for the years at issue.” 137 T.C. 8, at p. 3

Of course, the aim is to prevent otherwise exempt organizations (as NEA would be pursuant to Section 501(c)(5)) from making a profit on selling advertising in their publications to offset their non-publishing operating expenses, giving them an unfair advantage over taxpaying periodical publishers. The Regulations “fragment” taxable advertising income from exempt-function income.

NEA’s key claim was that their members had no “right to receive” the periodicals in exchange for their dues payments. First, NEA could stop publishing at any time, and the members had no legally enforceable right to receive the magazines. Second, NEA put the magazines on-line and not restricted to “members only”.

After much fencing between NEA and IRS, and after parsing of the term “right to receive”; with Judge Gustafson wading through law dictionaries, a U. S. Supreme Court First Amendment decision, Treasury Regulations, IRS Announcements, PLRs and unpublished Technical Advice Memoranda, Judge Gustafson concludes that the member did have the requisite “right to receive” the magazines, and NEA owes the UBIT.

NEA told its members what part of their dues was allocated to the magazines. The magazines were the vehicle by which NEA conveyed essential information mandated by NEA’s constitution and by-laws. Although NEA argued they could have stopped publishing at any time, they didn’t during the years at issue. Moreover, NEA stated in writing that their publication schedule was fixed a year in advance, and NEA had contracts with its advertisers. Result: NEA couldn’t establish that it could stop publication at any time. Thus, the members had enough of a “right to receive” the magazines to satisfy the Regulation at issue.

Finally, the on-line argument falls. NEA argued that anyone can read the magazines on-line, members and non-members alike, at no charge, so it cannot be fairly said that the members received the magazines in exchange for the payment of their dues, and thus had the right to receive them.

Judge Gustafson again, a jurist of great patience: “This contention is contradicted, however, by two facts:

“First, the Internet versions of the periodicals do not include all of the content of the paper editions. The paid advertising and the letters to the editor are available only in the print edition. The record includes no evidence that these features are of no value to members.

“Second, that NEA goes to significant expense and trouble to produce the paper editions shows that paper copies of the periodicals have value even in the Internet era. We take judicial notice of the fact that many periodicals have both online editions that one may access without cost and paper editions for which subscriptions must be paid. Evidently, a market still exists for paper publications. A user who has on-line access to a publication may still value receiving a paper copy. NEA put on no evidence that its members do not value the paper periodicals.” 137 T.C. 8, at p.35.

I can’t write a takeaway any better than Judge Gustafson did: “26 C.F.R. section 1.512(a)-1(f)(3)(iii), Income Tax Regs., requires an allocation of membership dues to circulation income if the exempt organization’s members have a legal right to receive the publications. For the years at issue, NEA members had such a legal right to receive the periodicals. The fact that NEA also made most of the content of the periodicals available on the Internet does not change this conclusion. Consequently, the IRS was correct in requiring NEA to allocate a portion of its membership dues to circulation income.” 137 T.C. 8, at p. 39.

501(c)s and your tax advisers, read and heed. And stand by for the inevitable appeal, as every 501(c) in the country with a magazine will be filing amicus briefs.

I may be preaching to the choir here, as the people who need this advice are the self-represented, the taxpayers who go to Tax Court pro se, because they can’t afford, or don’t want to pay, a tax professional admitted to Tax Court. But maybe the pros who read this can forewarn their “go-it-alone” clients– “don’t ever concede anything you want to dispute at trial anywhere”.

Case in point: Bernard J. Williams and Martha Williams, 2011 T.C. Mem. 227, filed 9/22/11. The fight is over nearly $60K in Schedule C expenses. Bernie was a mortgage broker in the “low dishonest decade” just ended. He claimed he split commissions with other brokers, but had a problem of proof. SNOD and petition both followed.

The tax year was calendar 2006. In November, 2009, Tax Court ordered Bernie and IRS to file a status report by February, 2010, stating “in particular, the progress made towards resolution, by settlement or otherwise, of the issues raised in this matter.” 2011 T.C. Mem. 227, at p. 6.

To paraphrase the late great John Lennon, you say that you want resolution? Judge Morrison takes up the story: “Pursuant to that order, the Williamses and the IRS filed a joint status report on February 5, 2010. The report stated that the Williamses conceded that the IRS’s adjustment to the Schedule C business-expense deductions was correct, which meant that they agreed that the allowable Schedule C business expense deductions were only $6,790. The status report was signed by counsel for the IRS and by both of the Williamses. The IRS pretrial memorandum stated that the parties had settled the adjustments in the notice of deficiency that related to the Schedule C business-expense deductions, a statement which is consistent with what the parties said in the status report. The Williamses did not prepare a pretrial memorandum. When the case was tried on December 8, 2010, Bernard Williams asserted that the Williamses were entitled to Schedule C business-expense deductions for $59,719.92 of commission expenses, an amount in addition to the $6,790.” 2011 T.C. Mem. 227, at p. 6.  [Footnote omitted.]

Maybe Bernie didn’t think the status report was binding on him, or he didn’t understand what he signed, or he forgot about what he signed, and the decision doesn’t say, but he was stuck.

Judge Morrison again:  “The status report bars Bernard Williams from contending that the deductible Schedule C business expenses are greater than $6,790. Whether the statement in the status report is considered a settlement or a stipulation, Bernard Williams is precluded from repudiating it. There is no evidence that it was based on fraud or mutual mistake. Allowing Bernard Williams to contend that the deductible Schedule C business expenses are greater than $6,790 would likely prejudice the IRS, which reasonably thought the issue had been resolved before trial. See Rule 91(e), Tax Court Rules of Practice and Procedure (stipulations are binding, although the Court may permit a party to contradict a stipulation if justice so requires).” 2011 T.C. Mem. 227, at pp. 6-7 [Citations omitted.]

In other words, if you can’t prove fraud or mutual mistake (presumably of fact), you’re stuck. Since you can’t ambush the Indians (see my post “Don’t Ambush the Indians, 4/7/11) or the accountants (see my post “Don’t Ambush the Accountants, Either”, 8/17/11), you can’t ambush the IRS by raising an issue at trial that they thought was disposed of  ten months before.

Nevertheless, Judge Morrison goes the extra mile and lets Bernie try to prove his Schedule C expenses case, notwithstanding that, as a matter of law, he is precluded.

Bernie strikes out. “Even if Bernard Williams is not precluded from contending that the correct commission-expense deductions totaled $59,719.92, he has failed to show by a preponderance of the evidence that he incurred any commission expenses. Although he testified that he paid commissions of $59,719.92, we disbelieve this testimony given the lack of documentary evidence and the lack of corroborating testimony.” 2011 T.C. Mem. 227, at p. 7, manifesting once more the leeway the Courts afford the pro se.

One wonders what the outcome would have been, had Bernie produced documentary evidence and corroborating testimony. Would the ambush have worked? Perhaps the excessive largesse Judge Morrison afforded Bernie was bottomed on the knowledge that his “evidence” would lack any probative value, and not change the resolution of the case .

Bottom line: anything in writing that concedes anything is binding and conclusive, even colloquies in Court that are transcribed. See my post “Mitigation and Inventory”, 4/20/11. Even if you agree to the settlement, your adversary (IRS) is not your friend.

Pro se taxpayer, beware!

Woody Guthrie’s Depression-era ballad comes to the rescue of hard-working Gary A. Lyseng in 2011 T.C. Mem. 226, filed 9/21/11. Gary’s case was tried March 31, 2010; we now get the decision.

Gary will get a 6662(a) accuracy penalty on his unsubstantiated deductions after the Rule 155 computation, but that’s not anything special. What’s of interest is the determination of Gary’s tax home.

Gary was born and raised in Bemidji, Minnesota, and lives with fiancée and Papa in the house he bought years before the year at issue. Like the narrator in Dion’s famous song, The Wanderer, he roamed around around around, working as a laborer in nuclear power plants at inspection time, in Minnesota and other States.

IRS claimed that, since all Gary’s gigs were temporary and in different places, he had no tax home and therefore no travel expenses from Bemidji to wherever. Bemidji might be his domicile and principal place of residence, but that was for his convenience.

But Gary was a staunch union man, and got all his gigs, both in and out of Minnesota, from the Laborer’s Union local in Bemidji.

Judge Swift follows Gary’s wanderings, and then deals with the key issue: “Section 162(a)(2) allows taxpayers to deduct travel expenses incurred while away from home in pursuit of a trade or business. In order to deduct travel expenses a taxpayer generally must show that he or she was away from home overnight when the expenses were incurred. The purpose of the deduction is to alleviate the burden on taxpayers whose business or employment require them to incur duplicate living expenses. For purposes of section 162(a)(2) the word ‘home’ generally means the vicinity of a taxpayer’s principal place of work or employment, not the taxpayer’s personal residence. A taxpayer may be treated as having no principal place of work when the location of his work is always temporary.

“However, when a taxpayer has no principal place of work, and when the taxpayer maintains a personal residence or family home remote from his temporary jobsite, the taxpayer’s home may be treated as his tax home if: (1) The taxpayer incurs duplicate living expenses while traveling and maintaining the home; (2) the taxpayer has personal and historical connections to the home; and (3) the taxpayer has a business justification for maintaining the home.”  2011 T. C. Mem. 226, at pp. 6-7.

Gary has duplicate living expenses (some at least substantiated), and a personal and historical connection to his Bemidji homestead, but what about business reasons?

Judge Swift answers the question: “Petitioner’s union has helped him find work in Minnesota, and it appears reasonable that he will continue to use his union and his address in Bemidji to obtain work in Minnesota…. Petitioner had an adequate business justification for maintaining a home in Bemidji.” 2011 T.C. Mem. 226, at p. 7-8. (Citation omitted)

So Gary prevails as to his tax home. Of course, he still has to substantiate his allowable expenses, where he finds difficulties. But he can join in, with full voice, in Woody Guthrie’s immortal words, “Oh you cain’t scare me, I’m stickin’ to th’ Union….”

You might be able to deduct the depreciation and get a tax loss, but you must have credentials and show you tried. That’s the takeaway on William L. Weller, 2011 T.C. Mem. 224, filed 9/20/11.

Bill was a Boeing build-up mechanic until he got laid off. Using inherited money, he bought a high-priced glider. He’d formerly instructed with the Boeing Employees Soaring Club, and held the FAA Certified Flight Instructor Airplane, Certified Flight Instructor Instruments, and Certified Flight Instructor Glider qualifications.

While grounded from Boeing, Bill set up a disregarded LLC and started a flying school. He kept the FAA mandated flying logs but no other books and records. He did advertise on the Web and in flying publications, handed out leaflets at flying locations, and worked week-ends during good weather (Bill was based in Washington State). Even when he got another job with a homebuilder, and after he got rehired by Boeing, he kept ‘em flying on weekends, but made no profit once he depreciated the glider. He also flew under the FAA 100-hour radar, which would have required more extensive inspections of his aircraft.

IRS claimed the flying school was a hobby. Flying is fun, Bill never kept business books and records, consulted with experts or formulated a business plan.

Judge Cohen finds for Flyin’ Bill. True, he didn’t have a business plan or business books and records, and he did fly under the 100-hour radar. But he did advertise, he cut out insurance for his glider when business didn’t justify the expense, and his efforts to attract pupils were more than sporadic. It’s true Bill has all the necessary FAA paperwork and did teach flying at the Boeing employees club, so maybe that counterweighs the facts that Bill never spoke to lawyers, accountants or business advisers about how to make money.

True, flying is fun, and Bill flew most weekends in good weather. But full-time employment is not required to show a profit motive, one can have more than one trade or business, and no one is required to prove suffering to show a profit motive.

There’s no evidence that any income was expected from asset appreciation (Bill never claimed his glider would get more valuable), nor had Bill ever conducted a similar business before.

Bill claimed that, without the paper depreciation write-off, he would have made money, but Judge Cohen says you cannot ignore depreciation in figuring profit.

Bill did have full-time employment with the homebuilder after the first year he ran the flying school, and then was rehired by Boeing in his old job title. Said Judge Cohen: “While substantial income from sources other than the activity may indicate that the activity is not engaged in for profit, a taxpayer’s lack of substantial income from sources other than the activity tends to indicate that an activity is engaged in for profit. Sec. 1.183-2(b)(8), Income Tax Regs. The legislative history of the Tax Reform Act of 1969, Pub. L. 91-172, 83 Stat. 487, discloses a particular concern about wealthy individuals attempting to generate paper losses for the purpose of sheltering unrelated income. See H. Rept. 91-413 (1969), 1969-3 C.B. 200, 244-245. We have no such concerns with respect to petitioner.” 2011 T.C. Mem. 224, at p. 13. Bill was no high-flying millionaire.

Finally, IRS did not contest that most of Bill’s flying hours were spent instructing students for pay, or for mandatory continuing FAA qualification.

Bill ultimately comes a cropper on unreimbursed business expenses, but those are unrelated to his flying business, and it’s the usual indocumentado story, no substantiation.

So there’s a Rule 155 computation on those, with penalties if Bill flunks the five-and-ten rule (greater of $5000 or 10% of tax required to be shown). But Bill’s flying business is a business.

No decisions from Tax Court for the last three days, barring one 7463 concerning the tax home of a tugboat captain, and I’d covered that issue in my post “Home Is Where the Heart Is”, 7/21/11.

But take heart; there is news. On August 19, 2011, IRS issued final regulations, effective August 23, 2011 on prima facie proof of mailing of time-critical documents to IRS. See TD 9543, effective for documents mailed after 9/21/04 (that’s no typo, the IRS means 2004). Certified or registered mail is still the only kind of mail that generates the prima facie proof. Even Priority Mail with Proof of Delivery isn’t good enough as prima facie proof, says IRS, because Congress never amended Section 7502(c). You can certainly mail that way, but, if IRS contests receipt, you’ll have to prove that you sent it and that IRS got it, and the printout from USPS isn’t prima facie proof.

TD 9543 says: “Section 7502 does not authorize the Treasury Department or the IRS to adopt a rule that would permit USPS services in addition to certified and registered mail to establish prima facie evidence of delivery. Congress has been clear when it intended to change section 7502 to allow proof of delivery by other means. In 1958, Congress amended section 7502 to provide the IRS with the authority to treat certified mail the same as registered mail. See Technical Amendments Act of 1958, Public Law No. 85-866 (72 Stat. 1606 (1958)). Congress also amended section 7502 to authorize the IRS to publish rules providing the extent to which a PDS is the equivalent of certified mail. See Taxpayer Bill of Rights 2, Public Law No. 104-168 (110 Stat. 1452 (1996)); Internal Revenue Service Restructuring and Reform Act of 1998, Public Law No. 105-206 (112 Stat. 685 (1998)). Similar legislation would be necessary to authorize the IRS to treat additional USPS services as prima facie evidence of delivery.”

Good luck with getting Congress to enact such legislation.

Private delivery services (PDS) are still includable as providing a means of prima facie proof of mailing, if Doug Shulman blesses the service in question.

For the other side of the coin, see my post “The IRS Loses a Double-Header”, 7/12/11, where the IRS couldn’t prove mailing of a determination in a 7623 whistleblower case.

And now, as Monty Python used to say, for something completely different.

Maybe a rant does help sometimes. I see the 2012 Nationwide Tax Forum is coming back to New York City in 2012, on August 28 through August 30. See you there, guys.

That’s what Judge Swift Tells IRS’ Lawyers

 The takeaway from Ada R. Santos, 2011 T.C. Sum. Op. 108, filed 9/12/11, is that lawyers, even IRS lawyers, should really read the law before writing their trial briefs.

The issues in Santos are the dependency deduction, EITC and HOH filing status. Ada supported her 100% disabled son Walter, who got Social Security (SSI) and Medicaid benefits for the year at issue.

Ada wins on all three, because tax law changes effective for the tax year at issue (2005) eliminated the half-of-support requirement. IRS argued that Ada had to show she provided one-half of Walter’s support. No, says Judge Swift, the 2004 amendments did away with that.

“A qualifying child means an individual who:  (1) Bears a qualifying relationship to the taxpayer (e.g., a child of the taxpayer); (2) has the same principal place of abode as the taxpayer for more than one-half of the taxable year; (3) meets the age requirement of section 152(c)(3); (4) has not provided over one-half of his or her own support for the taxable year; and (5) has not filed a joint return with his or her spouse, if any. Sec. 152(c)(1). There is no longer a requirement that a parent claiming a dependency exemption for a qualifying child have provided over one-half of the total support for the child.” 2011 T.C. Sum. Op. 108, at p. 4.

In deciding whether Walter supplied more than one-half of his own support, IRS wanted to include Walter’s Social Security benefits (SSI). OK, says Judge Swift: “The value of government benefits normally excludable from income (e.g., Social Security benefits) may be included in the term “support”. See Turecamo v. Commissioner, 554 F.2d 564,569 (2d Cir. 1977), affg. 64 T.C. 720 (1975); sec. 1.152-1(a)(2)(ii), Income Tax Regs.” 2011 T.C. Sum. Op. 108, at pp. 4-5.

Now the SSI was a known figure, but Walter’s Medicaid benefits weren’t, so IRS argued that Ada couldn’t show how much of Walter’s support Ada, as opposed to Walter via Medicaid, provided for himself.

No fair, says Judge Swift:  “We, however, have acknowledged that payments received under Medicaid are not necessarily included in determining the support of a claimed dependent. In Archer v. Commissioner, 73 T.C. 963 (1980), Medicaid payments received were held not to involve ordinary support for the mother of the taxpayer. The Court noted:

‘To require that Medicaid payments be included inthe support equation * * * means that those individuals whose parents are the neediest will be the least likely to get a dependency exemption for supporting * * *[their parents]. This * * * seems exceedingly unfair and contrary to the basic thrust of the Medicaid program itself. Id. at 971.’

“On the limited record before us, we find it appropriate to exclude Medicaid benefits Walter received in calculating the total amount of Walter’s 2009 support. ” 2011 T.C. Sum. Op. 108, at pp. 5-6.

As a last straw, IRS argued that the value of the support, not the dollar amount alleged or proven actually to have been spent, should govern. No again, says Judge Swift: “In determining whether a qualifying child has provided more than half of his or her own support, the amount of support provided by the child is compared to the total amount of support available to the child. However, we have explained that ‘a taxpayer is not precluded from being entitled to a dependency exemption simply because he is not able to prove conclusively the total cost of the child’s support’. Stafford v. Commissioner, 46 T.C. 515, 517 (1966).” 2011 T.C. Sum. Op. 108, at p. 6.

Judge Swift finds Ada proved her living expenses, that only she and Walter lived in her residence, and that the dollar amount of her expenses allocable to Walter exceeded his SSI by a sufficient margin to establish that Walter did not provide more than one-half of his own support.

Since Walter is a qualifying child, Ada gets the dependency deduction, the EITC and HOH filing status.

Note that Ada tried this case pro se. She did a lot better than IRS counsel.

Or, It’s Still the Same Old Story

Remember poor Murray S. Friedland, who has an unbroken record of disastrous failures in getting his whistleblowing paid for. See 2011 T.C. Mem 90, filed 4/25/11, where he was told by an IRS representative to file with U.S. Court of Federal Claims; that the advice was wrong didn’t help Murray when he filed with Tax Court 217 days after the “determination”, which took the form of the usual “laundry list letter” (see also Cooper, 136 T.C. 30, filed 6/20/11, and my blog “The Whistleblower Blows It” of the same date). Tax Court’s jurisdiction is limited by statute; a rejected whistleblower must knock on Tax Court’s door within thirty days after issuance of the determination. Jurisdiction comes from Congress. Jurisdiction cannot be created by estoppel.

But Murray, nothing deterred, tries again, this time in Murray S. Friedland, 2011 T.C. Mem. 217, filed 9/17/11. Once again, Murray drops a Form 211, Application for Award for Original Information on Ogden, UT. Once again, the laundry list goes forth, which Tax Court knows Murray receives because he starts telephoning IRS asking for reconsideration, objecting to the denial, and doing everything but immediately filing a petition with Tax Court. The last contact Murray has with IRS is March 11. He sends in his petition April 12.

Too late, says Tax Court. Even though IRS again futilely argued that their laundry list letter (“we have the info, it was public record, and we didn’t get any money”), dated in this case March 3, wasn’t a determination within the meaning of Section 7623, IRS still won, even though, as in Cooper, they couldn’t prove mailing to Murray’s last known address. Murray alleged his March 11 phone call and his protests therein, and that’s enough to prove he got the letter.

Moreover, even if Tax Court takes March 11 as the start date for Murray’s thirty days, he doesn’t file until April 12. Too late.

Moral: If you blow the whistle, don’t blow the 30-day filing period. Send in your petition on day one. If necessary, amend as of right or seek leave to amend (see Rule 41(a)). But don’t waste time with telephone calls, prayer or fasting. Get on your bike to 400 Second Street, N.W., Washington, DC 20217.

Or, You Can’t Use It If You Can’t Lose It

Aside from bringing the law up to speed with the technology of the cellular telephone business (and incidentally deciding that holding a license to operate a cellular phone system is not a trade or business, unless you actually are operating the system), Judge Kroupa breaks new ground in the at-risk rules of Section 465 in deciding Robert and Kimberly Broz, 137 T.C. 5, filed 9/1/11.

Bob was a banker who got into the cellphone business in a big way when the FCC ran a lottery for cell license to RSAs (Rural Statistical Areas, areas underserved or unserved by the big cell operators). Bob set up a series of Sub S Corps, some of which would buy and hold the licenses, and another would build out the infrastructure and operate the system.

Bob borrowed money through his operating Sub S to pay for some of his build-out work, and pledged the stock of one of his license-holding sub Ss to secure repayment. The issue for Tax Court was whether the license holder was related, and if so, whether that disqualified the taxpayer from using the loan secured by the pledge of that stock as part of the amount for which he was at risk (and thus could use as basis and take losses currently).

Here’s Judge Kroupa: “We must decide for the first time whether stock in a related S corporation is property used in the business to preclude petitioners from being at risk for any pledge of property used in the business.

“We begin with an overview of the at-risk rules. The at-risk rules ensure that a taxpayer deducts losses only to the extent he or she is economically or actually at risk for the investment. The amount at risk includes cash contributions and certain amounts borrowed with respect to the activity for which the taxpayer is personally liable for repayment. Pledges of personal property as security for borrowed amounts are also included in the at-risk amount. The taxpayer is not at risk, however, for any pledge of property used in the business.” 137 T.C. 5, at pp. 28-29.

The magic words, of course, are “used in the business.”

After disposing of Bob’s assertion that stock in a business is not “used in the business”, because it can be sold without affecting the business’ balance sheet, and therefore is separate from the business, by saying that such an argument is too narrow a view because of the close interrelationship between the two Sub Ss at issue, Judge Kroupa went on: “Pledged property must be ‘unrelated to the business’ if it is to be included in the taxpayer’s at-risk amount.” 137 T.C. 5, at pp. 29-30.[citations and footnote omitted]

The stock is related apparently because the corporations are related. But the ultimate argument is the smell test.

Judge Kroupa again:” Moreover, even if the … stock is unrelated to the cellular phone business, petitioners were not economically or actually at risk with respect to their involvement with the … entities. Petitioners contend that petitioner was the obligor of last resort on the … loan. Petitioners were not actually at risk because they never personally guaranteed the … loan, nor were they ever personally liable on the purported loans to the … entities. Additionally, petitioners were not economically at risk. We have held that where the transaction has been structured so as to remove any realistic possibility of loss, the taxpayer is not at risk for the borrowed amounts. We have already determined that the structured transaction made it highly unlikely that petitioners would experience a loss.” 137 T.C. 5, at pp. 30-31.[citations omitted]

Footnote 12 at p. 30, which I omitted above, adds another wrinkle. Bob pledged the stock that he claimed put him at risk to borrow the money he claimed he lent to his other Sub S. The footnote: “Furthermore, the flush language of sec. 465(b)(2) provides that no property shall be taken into account as security for borrowed amounts if such property is directly or indirectly financed by indebtedness which is secured by the property. The … stock qualifies as “property * * * directly or indirectly financed by indebtedness” because … borrowed the funds from CoBank. Petitioners’ pledge of … stock therefore cannot be taken into account to determine whether petitioners were at risk.”

So be careful before you pledge your stock in one of your Sub Ss to secure a loan for another one of your Sub Ss. Make sure they’re different activities, trades or businesses.

And remember, whether related or not, you can’t use it if you can’t lose it.

I said often enough that this blog is for the in-the trenches practitioner, not the writer of law review articles or newsletters for the two-yacht preparer. But Tax Court has an interesting take that has a good deal of general application.

This was Superior Trading, LLC, Jetstream Business Limited, Tax Matters Partner, et al., 137 T.C. 6, filed 9/1/11.

Judge Wherry was tasked with unraveling this son-of-DAD deal, where, like so many similar schemes, a pseudo but recognized loss is married to a real gain, and immediately afterward the parties unwind the deal, right after the real gain is shielded from tax. Like the currency trade shenanigans (see my blogpost of 4/14/11, “An Option Isn’t a Contract”), the DADs (distressed asset/debt) take distressed debt, which supposedly generates a massive loss, and ties it in to a real gain (the packager of the deal making a fee from selling the scam to the gainer, which is split with the distressed assetholder/debtor).

Take it away, Judge Wherry! “Instead of a claimed permanent tax loss manufactured out of whole cloth, a DAD deal synthesizes an evanescent one. The loss is proclaimed under authority of sections 723 and 704(c) from an alleged contribution of a built-in loss asset by a ‘tax indifferent’ party to a purported partnership with a ‘tax sensitive’ one. However, this loss is preordained to be nullified by a matching gain upon the dissolution of the venture. Consequently, the tax benefits sought by the tax sensitive party are, absent other factors, confined to timing gains. Moreover, claiming these benefits requires sufficient “outside basis”, which, in turn, entails an investment of real assets.” 137 T.C. 6, at pp. 4-5.

So here, a bankrupt Brazilian equivalent of Circuit City, which provided purchase-money financing to its customers who promptly defaulted, contributes all its allegedly worthless consumer paper to a partnership. The Brazilian partner, of course, has no effective connection with, substantial presence in, ever done business of any kind in or with, or even can find the USA on a map. Various characters sell partnership interests to US parties who need a quick write-off. The Brazilians claim their customers’ paper is worthless and take a huge write-off.

This loss winds up on the 1040s of the US investors who bought these partnership interests. Of course, TEFRA administrative partnership adjustments rain down on the heads of the US investors, who Judge Wherry styles as inhabitants of “Mr. Rogers’ Neighborhood.” Only this Mr. Rogers is not a Presbyterian minister, like the eponymous television personality; rather, this dude is Mr. John E. Rogers, who  “has a B.A. in mathematics and physics from the University of Notre Dame, a J.D. from Harvard Law School, and an M.B.A. from the University of Chicago, with a concentration in international finance and econometrics.” 137 T.C. 6, at p. 9. Clearly, Mr. Rogers’ credentials wow even the unflappable Judge Wherry, as he devoted a three-quarter-page footnote to Mr. Rogers’ glowing resume.

But Mr. Rogers’ tiered partnerships and swapping around of distressed debt was only a timing gain. Eventually, the gains would overtake the losses, but the timing benefit could be substantial, resulting in deferral of gain. In any event, Congress slammed the door on such shell games by the American Jobs Creation Act of 2004; distressed debt cannot be allocated among partners–the contributing partner keeps it all.

Ultimately, these pre-Act deals fall apart because the Brazilians and Americans never intended to go into business together. There was no real partnership; the Brazilians carried on their collection activities independently from the Americans, who played their own games on their own playgrounds. There was no common business. Tax Court concludes that the Brazilians sold their distressed assets to the partnership, and bought them back, a process known to some by the arcane technical term as “selling the chumetz”. And it doesn’t fly.

While it’s true that tax benefits can exceed true economic gain without denuding a transaction of economic substance, here there was no substantial business purpose to these partnerships. IRS wins.