It’s been quite a year; 125 posts and still enthusiastic. Best wishes to all.

Oliver Wendell Holmes, Jr., was known as “The Great Dissenter” on the US Supreme Court a hundred years ago. His intellectual descendant, Mark V. Holmes, the judge who writes like a person, has written a fine dissent in Randall J. and Karen G. Thompson, 137 T. C. 17, filed 12/27/11.

This is a son-of-BOSS phony partnership that was blown up six years ago, with decided cases sinking Randy. So Randy is precluded from fighting over business purpose, economic substance, or whether he owes IRS telephone numbers in tax, interest, and penalties. Even though Tax Court may have gotten its subject matter jurisdiction wrong back then, Randy never appealed, so he’s stuck with Tax Court’s determinations, even though there are later cases that went his way.

For a quick refresher on issue preclusion and claim preclusion, a/k/a collateral estoppel, see Judge Wherry’s lengthy footnotes numbers 22 and 23, at 137 T.C. 17, pp. 32-33.

The question here is Tax Court’s jurisdiction over affected items, that is individual partners’ tax items that follow from partnership items, but aren’t themselves partnership items. Once the partnership-level adjustment becomes final, TEFRA gives IRS the power to assess these directly to the partner without the need for a SNOD, if they are merely computational, so as not to waste time sending out SNODs for simple arithmetic problems.

IRS issued Randy a SNOD anyway as well as an assessment, since IRS Chief Counsel wanted belt-suspenders-and-crazy-glue, because no one could tell what was or was not a merely computational affected item.

IRS got the numbers wrong in Randy’s SNOD but corrected them. Anyway, says IRS, Randy’s items are merely computational, no partner-level fiddling is needed, so Tax Court has no subject matter jurisdiction. And IRS’ math errors are not “determinations”, so they don’t trigger Tax Court jurisdiction.

The majority, per Judge Wherry, holds that way, and throws out Randy’s petition.  Judge Wherry writes the brief that IRS should have written but didn’t, in 36 pages, and Judges Colvin, Halpern, Vasquez, Thornton, and Paris agree.

Judges Morrison and Gustafson wisely sat this dance out.

Judge Cohen concurs in result only without separate opinion, but Judge Goeke dissents, and Judge Kroupa agrees. The fact that the majority took 36 pages to decide they had no jurisdiction means that each case has to be weighed, says Judge Kroupa. The fact that the SNOD numbers were wrong doesn’t, as the majority claim, invalidate the SNOD. IRS did decide something, there was a determination, so Randy can go to Tax Court, even though he will be thrown out based on his prior unappealed Tax Court losses.

Now for Judge Holmes. He agrees that Randy can’t argue that he had outside basis or that he doesn’t owe the 40% substantial understatement penalty, because he lost on those and never appealed. But Judge Holmes challenges the majority’s analysis of whether an affected item requires partner level determinations. It’s the analysis that troubles Judge Holmes.

A computational adjustment is just the bottom-line change on the partner’s return caused by the change at partnership level. But there are two baskets into which these adjustments can fall. Judge Holmes: “Sometimes the IRS has to send each partner a notice of deficiency, sometimes the IRS can just directly assess each partner and send him a notice of computational adjustment, and sometimes the IRS has to do some combination of both. See sec. 6230(a); sec. 301.6231(a)(6)-1(a), Proced. & Admin. Regs.; see also Napoliello v. Commissioner, 655 F.3d 1060, 1063-1064 (9th Cir. 2011) (citing Olson v. United States, 172 F.3d 1311, 1317 (Fed. Cir. 1999)), affg. T.C. Memo. 2009-104.” 137 T.C. 17, at p. 43.

If the change at partner level arising from the affected item requires a determination at partner level, then the deficiency procedure must be followed. If the only change at partner level is a math item coming from the change at partnership level, then straight to assessment, no SNOD. Incidentally, partner gets no ticket to Tax Court with the concomitant stay of collection.

Once again, Judge Holmes says it in a footnote: IRS could clear this up in the abusive shelter area by creating a single-track deficiency procedure, where both partnership and partners are in it together. 137, T.C. 17, at p. 44, footnote 3. Cf. poor old Beverly Bernice Bang, 2011 T.C. Sum Op. 1, filed 1/4/11, and my blogpost “Bang-A Warning to Tax Matters Partners (and their advisors)”, 1/5/11. If Bev could have bailed on the jojoba deal for $2700 and avoided the $32,000 assessed against her twenty-two years later, I can’t think why she wouldn’t have done so. But back to Randy.

The majority says, it’s all math, so straight to assessment. Judge Holmes says, I’ll concede three of the four items IRS changed on Randy’s return are math, but number four, knocking out his loss on liquidation of the partnership, doesn’t even appear on the 1065.

That’s a paraphrase; now in his own words: “The majority says that we can go ahead and eliminate it anyway because we decided… that the partnership was a sham, and no one can take a loss in disposing of an interest in a sham partnership. I don’t disagree. But it doesn’t quite answer the jurisdictional question that we have– does a taxpayer get to come to our Court to learn this lesson, or does he have to go to a refund court to hear the same bad news?” 137 T.C. 17, at p. 46 (footnote omitted).

More to the point, can Randy use Tax Court’s stay of collection to try to stash his cash before the IRS descends upon him and his?

Judge Holmes goes on. Eliminating Randy’s outside basis doesn’t get the right tax, because the loss Randy claimed took into account the cash he got for supposedly selling his partnership interest on liquidation. IRS disallowed a loss greater than what Randy claimed, because IRS skipped a step; IRS didn’t merely get the math wrong, they got the formula wrong. So it’s not just a math error, or a pure math computation.

The issue, briefly, is whether the partner adjustment is a “work it out with a calculator” adjustment flowing from the partnership adjustment, or whether there’s a legal question involved. Reg. Section 301.6231(a)(6)-1(a)(2) gives examples of mere math adjustments, like changes in threshold for medical deductions based upon AGI where the partnership adjustment gives the partner more gross income, and thus a higher AGI, which involves nothing more than simple arithmetic.

But Judge Holmes finds there’s a legal question here: outside basis, that forms no part of a partnership return. And there was a determination– collateral estoppel operates to keep Randy from fighting the issue again.

Another point. “I also think that it’s important to consider, when thinking about whether a computational adjustment requires partner-level determinations, whether a partner had the opportunity at the partnership level to dispute all issues of law and fact that will affect the computational adjustment. Otherwise we may see cases like the Thompsons’ again in a collection due process proceeding.” 137 T.C. 17, at pp. 56-57. (citations and footnotes omitted).

Again, for Randy it doesn’t matter; he had his chance, and he blew it. But the “thick line” Congress drew between partnership adjustments and partner adjustments not involving partnership matters is blurred here by the majority, says Judge Holmes, and “(T)he silt we stir today will cloud the cases we plunge into tomorrow.” 137 T. C. 17, at p. 61.

Can’t say it better than that.

Or, The Limits of Game-playing

A certain Director at a major accounting firm directed my attention to the new Treasury Regulations concerning Cost Sharing Arrangements and Platform Contribution Transfers among controlled entities.

She suggested that small businesses, for whose tax advisers I am writing, might encounter such dealings, principally in-bound US corporations and LLCs controlled by foreign entities. Quoting from the introduction to these regulations, “(A) unifying underpinning of the section 482 regulations is that controlled transactions reflecting similar economics, regardless of the type of transaction (such as transfer of intangibles or provision of services), should be valued in accordance with similar principles and methods.” Simple enough.

And as today is a Federal holiday, wherefore  school is out at Tax Court, I thought I’d fish for interesting morsels in TD 9568, a/k/a 80082 Federal Register / Vol. 76, No. 246 / Thursday, December 22, 2011 / Rules and Regulations, wherein the new Regulations appear.

But as I read the first fifty or so of the 202 pages of TD 9568, it became clear that it would be a rare small US firm that encountered the deals to which the Regulations were directed.

Again quoting TD 9568, “(I)t has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collections of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that this rule applies to U.S. businesses and foreign affiliates that enter into cost sharing arrangements.

“Few small entities are expected to enter into cost sharing agreements, as defined by these regulations. Accordingly, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, these regulations were submitted to the Chief Counsel for Advocacy of the Small Business Administration (CCASBA) for comment on their impact on small businesses. CCASBA did not have any comments.”

Quite possibly the CCASBA’s eyes glazed over at the same point as mine did.

So I’ll take Treasury at its word, and presume my readers will rest content with my abstract of the Regulations, as follows. The calculations of cost and profit must be reasonable, and must be based upon arms’-length or equivalent transactions. You can’t have the right to reject future contingent payments. You can’t mix-and-match discount rates to get the results you want. Play nice, kids.

Takeaway–In the immortal words of the old cartoon about the schoolgirl’s book report, “This book told me more about penguins than I wanted to know.”

 Santa Claus May or May Not Be Coming, But Tax Court Has Something

With apologies to John Frederick Coots and Haven Gillespie, the authors of the 1934 classic “Santa Claus is Coming to Town”, I note that, before going off to celebrate, Tax Court plays surrogate Santa Claus, handing out coal to bad boys and girls. On Thursday last, Tax Court gave out five lumps. I’ll summarize them quickly, as (a) they have little instructional or entertainment value, and (b) I am instructed by a certain Director at a major accounting firm to discuss the IRS’ new Cost Sharing Agreement regs. The latter will get separate treatment.

First, Syed A. and Rafiunnisa R. Ahmed, 2011 T.C. Mem. 295, filed 12/22/11. Sy wins religious discrimination suit, footnotes the recovery on his return (because he got a 1099-MISC), but doesn’t pay tax. Although the general release he signs says he is surrendering any claims for “personal injuries”, Judge Wells says personal injuries are greater than physical injuries (my emphasis), and that’s what Section 104(a)(2) requires. Sy had a heart attack, he claims, and was made to work where he got nauseated from malodorous chemicals, but neither the complaint nor the settlement agreement itemized physical illness or injury, and the general release was the usual boilerplate. IRS wins.

Second, Illya Bell, 2011 T.C. Mem. 296, filed 12/22/11. Illya claims he was unemployed for ten years, but before that (the year at issue) he ran a landscaping business; he couldn’t get the records to show income and expense because of the order of protection his ex-wife got against him, and a criminal case he was dealing with. He went to an individual (qualifications unspecified) to have his taxes done. He claims she made up numbers, especially his income, although some (his deductions) were accurate. He claims he sent in the return without reading it, although he signed it under penalty of perjury. Judge Wherry says he must have had some of the expenses his return showed and that he testified to, so giving Illya a 75% Cohan haircut (proved allowable expense but not amount), he nevertheless refuses to abate one penny of Illya’s income as stated, and sticks him with nonpayment and accuracy penalties as well.

Third, John C. Hughes, 2011 T. C. Mem. 294, filed 12/22/11. John protests a notice of lien. He claims he had no equity in his house and moved out anyway. He also claims he has only Social Security to live on, the lien hurts his credit, he sometimes can’t pay his bills and his income is below the median income for his home state of Georgia. Judge Wells gets this prize package, and unwraps it thus. The lien covers all property, real and personal, now owned or hereafter acquired, until tax paid or lien expires as provided by law. If Johnny is broke now, tomorrow is another day, as they say in Georgia. Every tax lien hurts the taxpayer’s credit, but John never claimed he could pay what he owed if the lien were lifted, and even if he could pay if it were lifted, IRS has discretion. And half the population of Georgia has income below the median, cause that’s what the median is, Johnny, half above, half below. Oh yeah, and John hadn’t paid taxes for at least eight years. IRS wins.

Fourth, Wayne Lasier Wilmot, 2011 T. C. Mem. 293, filed 12/22/11. I wanted to give this more space, but on reflection it doesn’t deserve it. Lasier was an oceanographer-turned-photographer, but he still worked for NOAA and taught at Johns Hopkins. He claimed his $50K-plus annual losses from what he called his photography business. But he put no photographs into evidence, he had no business plan or separate business bank account, he turned down work because he didn’t like it, he lost money every year for six years; and even if IRS conceded in one subsequent year he was engaged in business, that doesn’t bind IRS for any other year, especially not the year at issue. Judge Morrison goes through the for-profit laundry list, and washes Lasier out.

Finally, Terry L. and Cheryl A. Wright, 2011 T.C. Mem. 292, filed 12/22/11. We’ve heard this same old song before, the foreign currency Section 1256 shuffle. Ter and Cher need to bury a big gain, so they buy offsetting euro options, like our old pals Ricky and Tari Garcia, 2011 T.C. Mem. 85, filed 4/13/11; see my blogpost “An Option Isn’t a Contract”, 4/14/11. As with Ricky and Tari, Ter and Cher could walk away if the price of the euro didn’t hit the sweet spot, they didn’t have to deliver the currency on the magic date if they didn’t want to, and the options weren’t traded on any exchange. Ter and Cher’s argument when confronted with Garcia? Tax Court was wrong about Garcia. Judge Wells’ reply: No we weren’t wrong, you’re wrong, you flunk the Section 1256(g)(2) tests, and you’re out.

Best wishes to all for a Merry and a Happy. And good health and prosperity.

 Or, Tax Court Litigation Can Be Hazardous to Your Health (Financial, if Nothing Else)

This is the lesson Judge Holmes, a judge who writes like a person and not like a lawyer, is trying to teach Erik McBride Thompson, in 2011 T.C. Mem. 291, filed 12/19/2011.

Erik started by trying to do good, and ended up by doing well. Erik, a son of the pioneers in tiny Milan, Minnesota (population 300), went to Stanford University. There, he earned three degrees. From there, he went to Truk, once Japan’s Gibraltar of the Pacific and now a proud member of the Federated States of Micronesia, with the Peace Corps. Leaving the South Pacific, he returned to Milan, where he ran the Prairie Sun Bank and the Prairie Land & Lumber Company. In short, Erik was a very big bullfrog in the Milan pond.

But the call of the islands was irresistible, so Erik imported 100 Trukians to work in the local meatpacking plant. This move prospered Milan so well that Erik got considerable green fallout therefrom. But domestic tranquility wasn’t enough; Erik decided the wars in Iraq and Afghanistan were immoral and illegal, so he had to do something.

Or rather, not do something: he didn’t file proper returns or pay his income taxes.

With the usual result. IRS descended upon the banker-lumberjack with Substitutes for Returns, SNODs and breathings of fire and slaughter. After Erik spent a year fiddling around in Appeals to no visible purpose, and filed his petition with Tax Court,  IRS sent Erik a Branerton letter (see Branerton Corp. v. Commissioner, 61 T.C.691, 692 (1974)) which is a way to commence informal discovery without resort to formal demands; to try to agree on exhibits and facts before hitting the real matters in dispute.

Erik’s reply was not quite in line. Judge Holmes: “‘You may be curious about my decision not to file * * * my actions are designed to call us back to the rule of law and stop the slaughter of innocents.’ The letter goes on at some length but leaves no doubt that Thompson intended to resist paying taxes because he disapproved of the wars in Iraq and Afghanistan.” 2011 T.C. Mem. 291, at pp. 4-5.

Erik waxed eloquent about the Nuremberg Principles. The Nuremberg Principles provided that compliance with the law would be no excuse for those tried if the conduct would be complicit in, for example, a crime against humanity. United States v. Malinowski, 472 F.2d 850, 856 n.7 (3d Cir. 1973). 2011 T.C. Mem. 291, at p. 5, footnote 5.

However, Judge Holmes was less concerned with Erik’s hypothetical trial before an international war crimes court than about his approaching trial in United States Tax Court, and told Erik that if he didn’t provide some evidence 14 days before trial, he would be precluded from producing any at trial.

So Erik coughed up some paper. Judge Holmes, however, moved things right along. “But when we called the case for trial, Thompson still banked on a continuance. As the Commissioner reminded us, however, Thompson had spent almost a year with the Appeals officer doing nothing. We therefore denied his request.

“This finally jolted Thompson into action.” 2011 T.C. Mem. 291, at pp. 5-6.

Erik claimed investment interest carryforwards that would wipe out his past due taxes. Judge Holmes explains in “people talk” what investment interest is, in footnote 7 at page 6 of his decision, to which I refer everyone. As I said, here is a Judge who uses “people talk”. And the best part of his decisions is in the footnotes, where he explains things.

Of course, Erik plays around with handing over documents, and IRS wants everything precluded, claiming that to let them in would reward Erik’s dilatory tactics. Judge Holmes says he’ll let the documents into evidence. “We take into account that the documents’ purpose was to substantiate the disputed expenses, which we find does not prejudice the Commissioner. Cf. Cagle v. Commissioner, T.C. Memo. 1993-217. We also recognize that Thompson is going at this pro se and for the first time. He would be unlikely to get such indulgence in the future, and we have other ways of discouraging delay. See sec. 6673.” 2011 T.C. Mem. 291, at p. 8, footnote. In the immortal words of the late great Conrad Veidt, “Ve haff our vays of making you talk.”

Erik has a problem with his investment interest claim. He can prove some payments of interest, but not that the loan  was intended, and the loan proceeds were used, to purchase investment property. “The purpose is crucial because it determines whether the interest paid is deductible. When we know a taxpayer paid a deductible expense, we sometimes can estimate the amount. See Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930). The converse does not hold true–knowing the amount (without more) does not let us estimate that an item is deductible.” 2011 T.C. Mem. 291, at p. 11, footnote 12.

Erik also claimed losses from a residential real estate rental operation. Judge Holmes unpacks this one: “The Commissioner argues that ‘petitioner was not able to establish that the rental activity was non-passive or that the activity was engaged in for a profit.’ Showing unusual chutzpah, Thompson blames the Commissioner for waiting too long to raise the issue of character of the losses. (At trial Thompson focused on the amount of the loss.)

“It’s true that if an issue is untimely raised–unfairly surprising the opposing party by not giving him a chance to adequately address it at trial–-we’ll refuse to consider it.

“But we disagree with Thompson’s premise. The Commissioner didn’t raise this issue for the first time on brief; he raised it at trial. (And considering Thompson hadn’t bothered giving the Commissioner anything relating to his deductions and losses until one week before trial, this was no small feat.)” 2011 T.C. Mem 291, at pp. 13-14 (Citations and footnotes omitted–but go back and read them).

Erik’s disputed deductions are disallowed for failure to sustain his burden of proof, and since no exception to penalties applies to him, Erik gets the full carload.

Not one whit deterred, Erik apparently girds his loins for future voyages of discovery before the panel of the USTC. “Petitioner is on a fact-finding journey through the Tax Court and any encouragement of delay, hindrance, or cost increasing would be directed at future proceedings. Petitioner does not ‘disregard * * * the rules of this court,’ but rather hopes to learn them and possibly use them in the future.” Answering Brief for Petitioner at 9-10.” 2011 T.C. Mem. 291, at p. 16, footnote 15.

To cool Erik’s ardor, Judge Holmes fires a parting shot: “A final word of caution. Thompson seems to welcome future opportunities to come to the Tax Court. We can help pro se litigants with legitimate claims, but not those who make frivolous arguments. Perhaps Thompson believes conflating the two is worth the risk; he is now cautioned that section 6673 allows the Court to impose sanctions of up to $25,000 on taxpayers making frivolous arguments.” 2011 T.C. Mem. 291, at p. 16 (footnote omitted).

Erik, you did good, you did well, now leave well enough alone.

Levy First, Notice Afterwards vs. Lien First, Notice Afterwards

Levy is OK even if Form 3552 notice comes after notice of levy, but not if notice of lien comes first, and Form 3552 comes after. Thus spake Judge Paris, in Michael J. Conway and Raymond T. Nakano, 137 T.C. 16, filed 12/19/11. Case will probably be cited as Michael J. Conway tout court, although both go  up together under Rule 122(a), fully stipulated.

Mike and Ray were officers of the ill-fated National Airlines, founded 1999, cratered 2000. They were responsible parties for filing returns and paying Section 9502(a) Airport and Airways Trust Fund taxes, which I never heard of either, but anyway the trust funds weren’t turned over, and IRS is looking for trust fund recovery penalties (TFRP). Mike and Ray had sued in Federal District Court for refunds after IRS denied their claims (and IRS only took three years to do so), but these taxes are Subtitle Ds, not Subtitle Cs, and so are not divisible and Section 6331(i) does not bar collection. Clear? Thought not.

Anyway, Mike and Ray lost all their District Court cases and Circuit Court appeals.

Ray is first one on the Tax Court chopping block. He claims he got Form 1058 Notice of Levy first, and then two weeks later he got Form 3552 Notice of Tax Due.

Mike is next. He got letter 3164B “we are attempting to collect”, two weeks later gets Letter 3172, Notice of Lien and Right to Hearing, and a week later gets his Form 3552.

Both guys get a CDP. They claim they didn’t get 60-day demand notices and therefore the lien and levy were invalid.

Originally Appeals were going to withdraw the notices and re-serve in both cases, but SO Villaverde, who made that determination, got promoted to Team Manager. His successor, SO Hernandez, agreed with him, but then the Manager overruled her, and decided IRS could proceed to lien and levy. Judge Paris furnishes a bemused footnote: “The record does not reflect whether the Appeals team manager who overruled SO Hernandez was former SO Villaverde or another person.” 137 T. C. 16, at p. 9 (footnote 7).

As to Ray and the Notice of Levy, Judge Paris: “Respondent [IRS] contends that he gave Nakano valid notice and demand when he issued Nakano the levy notice on May 22, 2006. The levy notice went beyond the typical notice of intent to levy by including a demand for immediate payment of the specific amounts of TFRP owed, listed by period at issue, within 60 days of the assessments. In this limited circumstance, the Court agrees that this levy notice constitutes notice and demand.

“‘The form on which a notice of assessment and demand for payment is made is irrelevant as long as it provides the taxpayer with all of the information required under * * * [section 6303].’ Hughes v. United States, 953 F.2d 531, 536 (9th Cir. 1992) (quoting Elias v. Connett, 908 F.2d 521, 525 (9th Cir. 1990)); see also Deputy v. Commissioner, T.C. Memo. 2003-210. Section 6303 requires only that the notice (1) state the amount of unpaid tax, (2) demand payment, and (3) be issued within 60 days of assessment. The levy notice here did provide Nakano with all of the information required under the statute because it listed the type and amount of unpaid tax for each tax period, explicitly demanded payment, and was sent within 60 days of the assessments. The Court therefore holds that respondent gave Nakano the notice and demand required by section 6303.” 137 T. C. 16, at p. 13.

Ray challenges the assessments, but gets no joy from Judge Paris, who finds no prejudice in the mischaracterization of the quick assessments here as “jeopardy” assessments, or IRS’ misstatement that the assessments were untimely.

So Ray goes down in flames.

Now for Mike. Mike says the Letter 3164B was inadequate notice. IRS says “yes it was, and anyway, we don’t need no stinkin’ letter, Mike was boss of National and knew he owed tax, he’d been litigating with us for years and lost every time.” No good, says Judge Paris. IRS did not follow the law, therefore abuse of discretion and Mike wins.

First, “(T)he Letter 3164B merely reflected that unpaid taxes were owed but did not state the amounts, types, or periods of the unpaid taxes. Respondent [IRS] contends that the Letter 3164B did not have to state the amounts owed because, by the time respondent issued the Letter 3164B, Conway’s multiple communications with IRS Appeals (before the assessments) regarding the amounts of the unpaid TFRPs had provided him with constructive notice. Even if Conway had previously seen the proposed assessments, section 6303(a) required respondent, after making an assessment of tax, to either leave notice and demand of payment at Conway’s “dwelling or usual place of business” or mail it to his last known address. Cf. Resyn Corp. v. United States (In re Resyn Corp.), 945 F.2d 1279 (3d Cir. 1991) (IRS’ filing of a proof of claim in bankruptcy did not satisfy section 6303(a) because it did not employ either of these notification methods). Therefore, since the Letter 3164B gave notice of nothing other than that unpaid taxes were owed, it did not constitute a valid postassessment notice and demand.” 137 T.C. 16, at pp. 15-16.

Judge Paris goes on: “Next, the lien notice did not constitute valid notice and demand under section 6303 and section 6321. Respondent’s argument assumes that the lien notice issued to Conway on June 1, 2006, can serve as both notice and demand under 6303 and notice under section 6320. This assumption is flawed. A tax lien imposed under section 6321 arises at the time of assessment, see sec. 6322, and is enforceable when a ‘person liable to pay any tax neglects or refuses to pay the same after demand’, sec. 6321 (emphasis added). Moreover, section 6320(a)(1) requires the Commissioner to notify ‘the person described in section 6321’ of the NFTL filing. (Emphasis added.) This person is the person liable to pay who has refused to pay after demand (emphasis by the Court). Thus, the Commissioner must issue notice under section 6320(a)(1) only after demand has been made and the person neglects or refuses to pay. Therefore, no notice can serve as both assessment notice and demand under section 6303 and also postlien notice under section 6320(a)(1).” 137 T.C. 16, at pp.16-17. One size does not fit all.

IRS went backwards. Lien first, notice afterwards. No can do.

IRS’ argument that Mike, as CEO of the downed airline, knew right well that he had to pay the trust fund tax, fares no better. Judge Paris shoots IRS down: “Respondent relies on Jersey Shore State Bank v. United States, 479 U.S. 442 (1987), to support his argument. Respondent’s reliance on Jersey Shore is misplaced. The penalty imposed on the bank in Jersey Shore was nonassessable and not subject to administrative collection procedures. Id. at 447. Thus, the Supreme Court’s reasoning in Jersey Shore does not support the proposition that any notice Conway may have had eliminated the need for respondent to issue notice and demand before the lien on Conway’s property arose.” 137 T.C. 16, at pp. 17-18. Mike’s notice of lien bites the dust.

So Mike wins, Ray loses. And although IRS’ administrative procedures here were far from admirable, they do get Ray’s property.

In 27 Pages or Less

 IRS has come up with fresh regulations on the due-diligence requirements for preparers of EITC returns. See my blogpost “The $500 Misunderstanding”, 10/25/11.

In 27 pages, IRS says that (a) providers of generic information about EITC to walk-ins at a tax preparer’s office are not non-signing preparers and don’t have to worry about the $500 penalty; (b) a firm cannot be subject to the $500 penalty unless one of the following three conditions is satisfied: (1) a member of the principal management of the firm knew of the failure to comply with the due diligence requirements; (2) the firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements; or (3) the firm failed to comply with its reasonable and appropriate compliance procedures through willfulness, recklessness, or gross indifference; and (c) retention of EITC records no longer runs three years  from filing of the return (because the taxpayer may take the return from the preparer and file it themselves, and preparer cannot know when, or whether, taxpayer filed), but for the period ending three years after the later of the date the tax return or claim for refund was due or the date it was transferred in final form by the tax return preparer to the next person in the course of the filing process.

Simple, huh?

Oh yes, and the economic impact on preparers will be “minimal.”

Nit-pickers, obsessive-compulsives and terminal insomniacs may find the complete text at FR Doc. 2011-32487 Filed 12/19/2011 at 8:45 am; Publication Date: 12/20/2011.

The old saying “the lawyer who represents himself has a fool for a client” is proven once more in Peter A. McLauchlan, 2011 T.C. Mem. 289, filed 12/19/11. Pete was a partner in a Texas law firm during the years at issue (identity of law firm sealed by Court at Pete’s request; pseudonymously AR), but tax wasn’t his area of expertise.

Of course, he prepared his own returns. And of course his firm affiliation can be found by doing a simple Google search. Sealing a person’s professional affiliation in the Internet Age is like trying to hide a Great White Shark in your bathtub, but we’ll keep it anonymous here.

At least he didn’t represent himself before Tax Court.

Pete claimed some Schedule C expenses that were reimbursable by his firm’s policy, with no countervailing custom or practice, and for some of which he was reimbursed. He had some pass-through charitables and depreciation, and those gimmes Judge Kroupa let him have.

As for the reimbursables, AR had a policy: “AR had a written reimbursement policy that specifically provided for reimbursement of certain indirect AR expenses. Reasonable travel expenses were reimbursable, including expenses related to client maintenance and development. Interoffice travel expenses involving an automobile were reimbursable. Lease and rental automobile expenses incurred for client travel were reimbursable. Business meals and entertainment were reimbursable if authorized and approved. Continuing legal education expenses were reimbursable if approved.

“The written reimbursement policy, however, also provided that in-town transportation (i.e., transportation within a 20- mile radius of an attorney’s home office) expenses and spousal travel expenses were not reimbursable.

“As a matter of routine practice, AR would reimburse other indirect AR expenses that were not provided for in the written reimbursement policy, including State bar membership expenses and professional organization expenses. AR did not have a limit on the amount for which a partner could be reimbursed. Reasonableness, rather, was the overarching standard for approving reimbursement of indirect AR expenses. AR would deem an expense unreasonable if it was personal, excessive or not in AR’s best interests.” 2011 T.C. Mem. 289, at p. 4.

Pete’s Schedule C expenses were, he claimed, unreimbursed expenses. IRS said if they were proper expenses properly paid (which they didn’t concede), they were partnership expenses paid by a partner, and therefore not deductible by the partner. Judge Kroupa: “Generally, a partner may not directly deduct the expenses of the partnership on his or her individual returns, even if the expenses were incurred by the partner in furtherance of partnership business. Cropland Chem. Corp. v. Commissioner, 75 T.C. 288, 295 (1980), affd. without published opinion 665 F.2d 1050 (7th Cir. 1981). An exception applies, however, when there is an agreement among partners, or a routine practice equal to an agreement, that requires a partner to use his or her own funds to pay a partnership expense. Id.; Klein v. Commissioner, 25 T.C. 1045, 1052 (1956).

“The AR partnership agreement required petitioner to pay indirect AR expenses that were unreimbursable. There was no routine practice at AR that required petitioner to pay any other AR expenses. Accordingly, the expenses at issue are deductible if they were (1) indirect AR expenses, (2) unreimbursable and (3) actually incurred.” 2011 T. C. Mem. 289, at pp. 6-7.

Examining the expenses, the AR partnership agreement, and Pete’s own “general and vague” and “self-serving, unverified and undocumented” testimony (2011 T.C. Mem. 289, at p. 9), Judge Kroupa finds Pete never was denied reimbursement for anything he claimed, and his in-town, nonreimbursable automobile deductions hit the Section 274(d) roadblock. Strict substantiation: nothing else will serve, but again Pete offers only “general, vague, self-serving and uncorroborated testimony”, 2011 T. C. Mem. 289, at p. 11.

Game over for Pete’s Schedule C.

Now for the Section 6662(a) accuracy penalty. After the ritual incantation, Judge Kroupa nails Pete: “A taxpayer is not liable for an accuracy-related penalty, however, if the taxpayer acted with reasonable cause and in good faith with respect to any portion of the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including the taxpayer’s efforts to assess his or her proper tax liability, the knowledge, experience and education of the taxpayer, and the reliance on the advice of a professional. Sec. 1.6664-4(b)(1), Income Tax Regs.

“Petitioner is well educated and has been an attorney for over 20 years. He prepared his own Federal income tax returns for the years at issue. Petitioner admitted that he had difficulty preparing his tax returns, yet he failed to seek the assistance of a tax professional.

“Moreover, the full amount of each underpayment resulted from petitioner repeatedly disregarding the rules and regulations on reporting income and claiming deductions against income. Petitioner failed to offer any persuasive evidence that he acted with reasonable cause and in good faith in disregarding the relevant rules and regulations.” 2011 T. C. Mem. 289, at pp. 12-13.

So Pete loses–all the way.

Takeaway–Hire your tax professional before you get to trial. Hire them even before you do your own return.

Or, The Big Payday

 Papa Allen and his sons are fighting over the boodle, when the kids bought out Papa via a cashless stock option in Allen L. Davis, et al., 2011 T.C. Mem. 286, filed 12/12/11. Judge Kroupa faces an all-star cast of lawyers in this consolidated proceeding (fourteen for the battling Famous Famiglia Davis, and four for IRS). This is a “whipsaw”–someone owes big-time tax, and IRS doesn’t care who.

Briefly, Papa Allen fronted the kids $100K to open a business called Check-N-Go, a payday lender. In the old days, it was six for five in seven days, or three broken fingers in eight; the sharks would lend a worker five dollars and get back six dollars in seven days. Should the worker not pay, the appropriate digits would. Now, in these enlightened days with direct wage deposit, the shark just gets a check in advance for the amount lent, and cashes it electronically on the magic day–perfectly legal–and nobody gets hurt.

Now the business took off. Papa Allen just happened to have been a banker, and he had to stay in the business so the kids could get bank loans and expand the business. Did they ever; the business grew at a 37% annual rate. Now the business was a Sub S, with the kids, and some of their cronies who also bankrolled them in the earlies, as shareholders, along with Papa Allen.

There were various buyout and rights of first refusal, so when Mama Allen tried to dump Papa Allen and grab half his stock, the kids threatened to use the buy-sell to pick Mama Allen’s pocket on the way to the courthouse.

Finally, Papa Allen wants to take the money and run, he and the kids having taken turns kicking one another off the Board of Directors and out of management. The kids were now making it on their own (we don’t need no stinkin’ gratitude). So Papa Allen cashes out for $36 million, according to IRS, and $25,31,378.30, (so in original, at p. 14) according to Papa Allen’s pet appraiser, via a redemption of his stock, called the cashless option, by the corporation per an amended buy-sell. Judge Kroupa dumps the appraisal, stating that the stock could not be readily valued, the strike price for the redemption was negotiated after the kids had fought with Papa Allen, and so the price was freely negotiated. And to use Papa Allen’s appraiser’s valuation means the corporation would be taking a big loss on the redemption.

Now Papa Allen claims he had no income from the redemption. And, he claims, the corporation, which treated the payout to Papa Allen as compensation, has no deduction. The corporation (the kids and cronies) claim yes, it was compensation and we have the deduction. IRS says “we don’t care, talk among yourselves, but someone is paying tax.”

Judge Kroupa says the kids credibly testified that Papa Allen got the redemption deal because they needed to keep him in management to secure bank financing, and needed his banking creds to keep their lenders happy. Besides, the redemption agreement required Papa Allen to notify the corporation if he was electing Section 83(b) treatment and recognizing gain in the year he got the redemption option. If it isn’t compensation, Section 83 doesn’t apply, so why mention it?

Now that it’s compensation, is it reasonable? Section 162 doesn’t help. But Judge Kroupa takes a practical approach. “At the time the agreement was entered into, it was fair to CNG [the corporation]. Allen threatened to leave CNG unless he was given the opportunity to maintain his ownership interest in CNG. CNG, however, needed Allen to secure financing. The bank group extended CNG credit only because of Allen’s experience at Provident, and the covenant in the credit agreement required Allen’s participation in the day-to-day management of CNG. CNG needed that financing to fuel its exponential expansion.

“CNG was exceptionally successful from the time the Allen Option was granted to the time it was exercised. During that period, CNG opened 272 new stores. CNG’s revenues increased approximately 37 percent from $199.3 million to $272.7 million, and its EBITDA increased approximately 40 percent from $44.6 to $62.3 million.

“This success was mostly attributable to Allen. CNG could not have expanded as quickly as it did without Allen because the covenant requiring Allen’s participation in CNG’s management was not removed until the credit agreement was renegotiated in September 2004. ‘An employee responsible for the financial success and growth of a large and complex enterprise is entitled to substantial compensation.’ Lundy Packing Co. v. Commissioner, T.C. Memo. 1979-472; see also Albert Van Luit Co. v. Commissioner, T.C. Memo. 1975-56.” 2011 T. C. Mem. 258, at pp. 19-20.

So with this tribute to his business acumen and managerial skill, Judge Kroupa sticks Papa Allen with $36 million in income, and a Rule 155 bean-count to enjoy. Meantime the kids and cronies split a $36 million flow-through deduction against ordinary income.

Takeaway–Nothing like building a successful business to get you slammed by your family and the IRS.

Or,  If You Want a Refund, Ask For It

Taking his cue from John Osborne’s 1956 London hit, thus instructs STJ Dean, in Abdelrahman Rabie, 2011 T.C. Sum. Op. 137, filed 12/12/11. AbRab overpaid his taxes in the year at issue, but IRS issued a SNOD claiming he underpaid. After concessions, everyone agrees AbRab overpaid. But the lookback in Section 6512(b)(3)(b) bars his refund.

AbRab never filed his return for that year until three and a half years later. He did timely file an undated 4868 auto-extension, but that showed a balance due. Then,  two years after his return was due (as extended), he sent IRS a letter apologizing for not filing but claiming he always got a refund in the past. He  sent in a return, and what he styled a “corrected return”, a year after that, which “corrected return” everyone agrees finally got AbRab’s numbers right.

Now, does AbRab get a refund? STJ Dean says no.

“A taxpayer seeking a refund of overpaid taxes ordinarily must file a timely claim for a refund with the IRS that meets the requirements of section 6511. That section contains two separate provisions for determining the timeliness of a refund claim: The taxpayer must file a claim for a refund ‘within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid.’ Sec. 6511(a)(1).

“Section 6511 also defines two ‘lookback’ periods: if the claim is filed ‘within 3 years from the time the return was filed’, then the taxpayer is entitled to a refund of the portion of the tax paid within the 3 years immediately preceding the filing of the claim plus the period of any extension of time for filing the return. Sec. 6511(b)(2)(A). If the claim is not filed within that 3-year period, then the taxpayer is entitled to a refund of only that ‘portion of the tax paid during the 2 years immediately preceding the filing of the claim.’ Sec. 6511(b)(2)(B). If no claim has been filed the refund cannot exceed the amount that would be allowable under section 6511(b)(2)(A) or (B) if a claim was filed on the date the refund is allowed. Sec. 6511(b)(2)(C).” 2011 T. C. Sum. Op. 137, at pp. 4-5.

Clear, right?

AbRab says he did make a claim, albeit informally, in his 4868 or in his “so sorry but I always get refunds” letter. And those, he says, were timely.

No, says STJ Dean. Even though the courts have accepted claims even so vague that IRS rejected them out of hand (provided they were timely amended to demystify), “(I)t is not enough, however, that the facts supporting the claim reach the IRS in some ‘roundabout’ fashion. ‘The evidence should be clear that the Commissioner understood the specific claim that was made even though there was a departure from form in its submission.’” 2011 T. C. Sum. Op. 137, at pp. 5-6 [Citations omitted.]

In fact, even a 37-page letter was found insufficient in Martin v. United States, 833 F.2d 655 (7th Cir. 1987), because “…to be considered an adequate informal claim, the writing must be ‘sufficient to apprise the IRS that a refund is sought and to focus attention on the merits of the dispute so that an examination of the claim may be commenced if the IRS wishes.’” 2011 T.C. Sum. Op. 137, at p. 7. The taxpayer in Martin never said a refund was wanted, or demanded an IRS administrative review of the return.

IRS need not launch an independent investigation into every piece of paper or e-correspondence it receives. IRS need not, like Peer Gynt in Ibsen’s play, “go round about”. AbRab never said “I want a refund.” He only said he always got one before, and took three and a half years to get the numbers right. His 4868 was insufficient, because it showed a balance due. Even so, in the past a 4868 was held to be sufficient notice when taken together with other documents submitted by the taxpayer (Kaffenberger v.United States, 314 F.3d 944, at pp. 955-956 (8th Cir. 2003). But AbRab’s letter wasn’t specific enough.

Nevertheless, AbRab might be OK in Tax Court, even if not with IRS.

“A taxpayer seeking a refund in this Court, however, does not need to actually file a claim for refund with the IRS. He need only show that the tax to be refunded was paid during the applicable lookback period. Sec. 6512(b). In this case, the applicable lookback period is set forth in section 6512(b)(3)(B), which provides that this Court cannot award a refund of any overpaid taxes unless it first determines that the taxes were paid ‘within the period which would be applicable under section 6511(b)(2) * * * if on the date of the mailing of the notice of deficiency a claim had been filed (whether or not filed) stating the grounds upon which the Tax Court finds that there is an overpayment’.

“Section 6512(b)(3)(B) treats delinquent filers of income tax returns less favorably than those who have filed timely. Whereas timely filers are most likely to have the opportunity to seek a refund in the event they are drawn into Tax Court litigation, a delinquent filer’s entitlement to a refund in Tax Court depends on the date of the mailing of the notice of deficiency. Section 6512(b)(3)(B) directs the Tax Court to measure the lookback period from the date on which the notice of deficiency is mailed and not the date on which the taxpayer actually files a claim for refund. In the case of delinquent filers, section 6512(b)(3)(B) establishes only a 2-year lookback period, so the delinquent filer is not assured the opportunity to seek a refund in this Court. If the notice of deficiency is mailed more than 2 years after the taxes were paid, the Court lacks jurisdiction to award the taxpayer a refund.” 2011 T. C. Sum. Op 137, at pp. 9-10. {Citations omitted.]

Unhappily for poor ol’ AbRab, the SNOD got mailed to him after the three-year window had closed, so he was out of luck even if the three-year lookback applied.

Takeaway–Every letter to IRS should say “I want a refund”. If you file a 4868 and can state in good faith that you overpaid, write on the front in big letters “I want a refund”. And tell ‘em AbRab sent you.