To take a leaf from Stephen Sondheim’s and Leonard Bernstein’s song “When You’re a Jet” from the 1957 hit musical “West Side Story”. In this case, a 501(c)(3) exemption doesn’t disappear, even though the corporation did pay unrelated business income tax (UBIT) in three years of its hundred-year life, and unrelated debt-financed income tax (UDFIT) in two other years, when the corporation gets an employer reversion from a qualified retirement plan. That would ordinarily trigger a Section 4980(a) 20% excise tax.

But Research Corporation dodges the proverbial bullet in the eponymous case, Research Corporation, 138 T.C. 7, filed 2/29/12, a leap year bonus from Judge Haines. It’s a case of first impression.

Briefly, Research was a 501(c)(3) from the day 501(c)(3) first showed up in IRC 1954. Research was incorporated in 1912, and was exempt when the income tax was first inflicted in 1916. Research did have some UBIT to pay back in the 1950s, and some UDFIT in the early years of the current millennium.

Research had a defined benefit retirement plan for its employees from 1961 until 2003, which from inception through amendment always got favorable letters from IRS. In 2002, Research terminated the plan, setting up a $5.8 million reversion, but rolled 25% of that into a new plan, having gotten a favorable PLR that the reversion would not constitute UBTI to Research under Section 512(a)(1) (but interestingly, Research withdrew the part of its ruling request relating to Section 4980 treatment).

Research filed Form 5330 with respect to the reversion for 2003, but only paid the ratio that its lifetime UBIT and UDFIT bore to its entire income for three years, around $14K. IRS issued a SNOD for the whole enchilada, around $4.4 million, in 2010, claiming that by filing the Form 5330 and paying the $14K, Research conceded its liability for the Section 4980 excise tax.

Judge Haines blows off the concession argument in a footnote: “We do not view either the submission of Form 5330 or the statement as a concession. We note that all concessions are subject to the Court’s discretionary review and may be rejected in the interests of justice. If the submission of the Form 5330 and the statement contained therein can be viewed as a concession, we reject it. Petitioner has maintained throughout this proceeding in its petition and its briefs that it is not subject to excise tax.” 138 T.C. 7, at p. 6, footnote 2 (Citation omitted).

IRS conceded that Research never made any contributions to any of its employee plans to offset either UBIT or UDFIT whenever it owed any,  so no tax benefit inured to Research from any contributions.

Also of interest, Research never raised SOL, even though the SNOD was issued more than six years after the filing of the Form 5330, so Judge Haines deemed the argument waived. Possibly Research didn’t raise SOL because it also sought a refund of the $14K in the case (but it loses on that one on Section 6512(b)(3) grounds…too many years gone by since filed and paid, so no Tax Court jurisdiction to award a refund).

The whole case goes off on Section 4980(c)(1)(a). The excise tax applies to a “qualified plan”. IRS claims Research’s plan was qualified; Research says no. The magic language: “The term ‘qualified plan’ means any plan meeting the requirements of section 401(a) or 403(a), other than a plan maintained by an employer if such employer has, at all times, been exempt from tax under subtitle A. Sec. 4980(c)(1)(A).” 138 T.C. 7, at pp. 8-9. (Emphasis by the Court.)

But Research wasn’t “at all times” exempt, says IRS. They paid UBIT three times, and UDFIT twice, since 1954.  Those are both Subtitle A taxes, so Research wasn’t exempt at all times.

Judge Haines buries that argument with Section 501(b), as to the plain meaning of which he finds that, notwithstanding the UBIT and UDFIT, which Section 501(b) states does not disqualify a 501(c)(3) like Research, Research never lost its 501(c)(3) exemption.

IRS says it’s not seeking disqualification of Research as a tax-exempt, but to collect an excise tax, not an income tax. More magic language from Judge Haines: “Respondent [IRS] would like us to ignore the plain language of section 501(b), which provides that a section 501(c)(3) organization shall be subject to tax to the extent it has UBTI but, notwithstanding any unrelated business income tax paid, the organization ‘shall be considered an organization exempt from income taxes for the purpose of any law which refers to organizations exempt from income taxes’.” 138 T.C. 7, at p. 12. (Emphasis by the Court.)

Any law means any law. And the issue isn’t whether Research or any 501(c)(3) ever paid any tax. It’s whether Research was exempt under Subtitle A, because that’s what the plain language says.

IRS wants Tax Court to look at legislative history. Not necessary, says Judge Haines, because no ambiguity. But he’ll humor IRS. Here’s IRS’ last hope: “‘The agreement provides that the excise tax does not apply to a reversion to an employer that has at all times been tax-exempt. Of course, this exception does not apply to the extent that such employer has been subject to unrelated business income tax or has otherwise derived a tax benefit from the qualified plan.’ H.R. Conf. Rept. No. 99-841 (Vol. II), at II-483 (1986), 1986-3 C.B. (Vol. 4) 1, 483.” 138 T.C. 7, at p. 16. IRS says the sentence is disjunctive, and therefore either portion applies; so if Research ever paid UBIT, they must pay excise tax on the whole unrolled-over reversion.

No, says Judge Haines: “We do not agree with respondent’s argument. Respondent [IRS] ignores the phrase “to the extent”. That phrase limits the application of the legislative history to a specific set of facts. When coupled with the phrase “or has otherwise” the legislative history addresses a set of facts where the tax-exempt organization, whether it incurred unrelated business income tax or not, derived a tax benefit from the qualified plan. Respondent has conceded that petitioner did not derive a tax benefit from the plan.” 138 T.C. 7, at pp. 16-17.

So Research loses the $14K refund in Tax Court, but dodges the $4.4 million bullet. Not a bad swap.

When It Comes to SE Tax

 A net operating loss (NOL) from a trade or business, whether operated as a partnership or derived from from self-employment, whether carried forward or carried back, is generally a valid deduction. But where? Here’s the story of Joe Decrescenzo, or more properly, Joseph Decrescenzo, 2012 T.C. Mem. 51, filed 2/27/12, Judge Marvel at the helm.

Joe was a CPA who got a heavy-duty SNOD. After extensive negotiations between Joe and IRS, the only thing left for determination was where Joe could take a $51K NOL, on his Schedule C or on his 1040. If on his 1040 and not his Schedule C, he owes $15K in SE tax.

After Joe’s arguments about burden of proof are dismissed (there’s nothing to prove, as he and IRS stipulated everything but the one question of law), Judge Marvel goes to the magic language of Section 1402(a)(4): “'(E)arnings from self-employment’” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss–

* * * * * * *

(4) the deduction for net operating losses provided in section 172 shall not be allowed;” 2012 T.C. Mem. 51, at p. 8.

Joe argues that paragraph (4) applies only to partnerships, not individuals like him, since paragraph (5) begins with the word “if”, and goes on to discuss partnerships. Judge Marvel buries that one in a footnote: “Petitioner contends that para. (4) of sec. 1402(a) does not apply to individuals but instead applies only to partnerships. He contends that, because para. (5) of sec. 1402(a) begins with the word “if,” para. (4) of sec. 1402(a) is applicable only if the taxpayer meets the requirements of either subpar. (A) or (B) of sec.  1402(a)(5). Paragraphs (1)-(17) of sec. 1402(a) set forth specific rules for computing net earnings from self-employment. Each numbered paragraph contains a separate rule. Paragraph (4) of sec. 1402(a) operates independently of para. (5) of sec. 1402(a), and the application of para. (4) of sec. 1402(a) is not dependent on the taxpayer’s satisfaction of subpar. (A) or (B) of sec. 1402(a)(5).” 2012 T. C. Mem. 51, at p. 9, footnote 6.

There’s a bushelbasket of cases holding you can’t take NOL against SE. Joe tries to distinguish only one, and fails.

So Joe has the deduction on his 1040. But since he stipulated to the additions to tax if he lost on the SE, he owes those. He tries to get out of the stipulation, saying he suffers from acute anxiety disorder and couldn’t attend the trial, but Judge Marvel kicks that one to the footnotes again: “While petitioner argues that he was unable to appear at trial because of an acute anxiety disorder, he introduced no evidence that he was suffering from the acute anxiety disorder at the time he executed the stipulation. See King v. Commissioner, 121 T.C. 245, 252-253 (2003). Petitioner is bound by the stipulation of settled issues.” 2012 T. C. Mem. 51, at p. 11 (continuation of footnote 8 from p. 10).

I can understand anyone being acutely anxious about taxes, even a CPA like Joe.

Or, Sly and the Family Stone  Do It Right

That’s the lesson Judge Goeke has for us in Estate of Joanne Harrison Stone, Deceased, Cosby A. Stone and Michael D. Stone, Personal Representatives, 2012 T.C. Mem. 48, filed 2/22/12.

The late Jo was a Sunday school teacher for 60 plus years, up to the Sunday before she died, at the age of 81. In her spare time, she and husband Roy produced six children, and the six produced a platoon of grands.

When not spreading the good news, Jo worked with Roy and some of their kids in the family publishing business, while acquiring 740 acres of Cumberland County, Tennessee. To create a lake next to the property of son Steve, and to protect and preserve (and maybe develop), along with kids and grandkids, the woodland parcels next the lake site, Jo and Roy set up the Stone Family Limited Partnership (FLP), under the guidance of local attorney Harry Sabine (and I mention his name because he got it right, and saved his client’s estate $2.5 million in estate tax).

They had the land appraised (and this appraisal was apparently so good IRS didn’t attack it),  gifted limited partnership interests to kids, kids’ spouses and grandkids (inartfully, but well enough to survive), and paid gift tax based upon the appraisal (with no blockage or fractional interest discount).

The issue here is the Section 2036(a) landmine. Did Jo still have enough hold on the partnership assets so that they belong in her estate?

Judge Goeke unpacks the Section 2036(a) landmine thus: “Section 2036(a) generally provides that if a decedent makes an inter vivos transfer of property other than a bona fide sale for adequate and full consideration and retains certain enumerated rights or interests in the property which are not relinquished until death, the full value of the transferred property will be included in the decedent’s gross estate. Section 2036(a) is applicable when three conditions are met: (1) the decedent made an inter vivos transfer of property; (2) the decedent’s transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest or right enumerated in section 2036(a)(1) or (2) or (b) in the transferred property which he or she did not relinquish before death.” 2012 T.C. Mem. 48, at pp. 10-11.

Most important in establishing adequate and full consideration, there was a bona fide non-tax purpose in the FLP. “Testimony at trial established that a significant purpose of decedent’s transfer of the woodland parcels to SFLP was to create a family asset managed by decedent’s family. Decedent and Mr. Stone desired that their children, their children’s spouses, and their grandchildren work together to develop and sell homes near the lake. We have previously found that a desire by a decedent to have assets jointly managed by family members, even standing alone, is a sufficient nontax motive for purposes of section 2036(a).” Estate of Mirowski v. Commissioner, T.C. Memo. 2008-74.” 2012 T.C. Mem 48, at p. 14.

When two of their kids divorced, and the outgoing spouses deeded back their interests in the land (but not in the FLP),  and Jo and Roy paid the nominal real estate taxes from their own funds and not FLP funds, IRS attempted to blow up the FLP because partnership formalities weren’t followed. But Judge Goeke didn’t buy it.

“We agree with respondent that the partners of SFLP failed to respect some partnership formalities.

“Other factors, however, support the estate’s argument that a bona fide sale occurred. First,  decedent and Mr. Stone did not depend on distributions from SFLP as no distributions were ever made. Second, decedent and Mr. Stone actually did transfer the woodland parcels to SFLP. Third, there was no commingling of partners’ personal and partnership funds, as SFLP had no partnership funds. Fourth, no discounting of SFLP interests for gift tax purposes occurred; decedent and Mr. Stone had the woodland parcels appraised and valued the SFLP interests so that that the total value of SFLP interests was equal to the appraised value of the woodland parcels. Finally, the evidence presented tended to show that decedent (and Mr. Stone) were in good health at the time the transfer of the woodland parcels was made to SFLP. Although decedent was over age 70 at the time of transfer in 1997, she lived until 2005 and was healthy enough to continue teaching Sunday school up to and including the last Sunday before she passed away. Although Mr. Stone was over age 80 at the time of transfer, he was still alive at the time of trial in June 2011.” 2012 T.C. Mem. 48, at pp. 16-17.

Thereby the late Jo’s estate avoids the Section 2036(a) landmine. Good job, Harry.

Such is the lesson of Robert B. Anderson, 2012 T. C. Mem. 46, filed 2/21/12. Bob was accused of frivolity for his 2006 and 2007 returns, which showed zero. However, his 2008 and 2010 returns showed (apparently valid) refunds, which IRS grabbed, thus satisfying IRS’ claims for 2006 in full, while Bob’s timely CDP request was pending.

Bob never got a SNOD, just a letter stating he was frivolous. Bob’s request for a collection alternative went down in flames when he failed to file a Form 433-A, despite two requests from IRS.

IRS moves for summary judgment on 2006; Bob is fully paid up via the grab of his 2008 and 2010 refunds, so nothing more to fight about. Bob cries “foul, they grabbed my refunds while my CDP was pending, which was a levy, and CDP suspends all collection activity.”

Nope, says Judge Halpern. This was an offset, not a levy. There’s Circuit Court of Appeals learning on this point (Boyd v. Commissioner, 124 T.C. 296, 300 (2005), aff’d, 451 F.3d 8 (1st Cir. 2006). Yer out, Bob. 2006 is history.

But as for 2007, IRS wants partial summary judgment. No go, IRS, says Judge Halpern. Even though Bob attached to his CDP request a preprinted 23-item checklist (on which he checked 21 items), and all but two seemed frivolous: “[R]espondent appears to argue for summary adjudication in his favor with respect to the first assignment of error on the ground that petitioner’s initial 2007 return, showing zero wages, was incorrect ‘due to petitioner’s frivolous position echoed in his CDP request, petition, and amended petition.’ While there is much in the attachment to the CDP request, the petition, and the amended petition that strikes us as frivolous, paragraph 7 of the attachment does state that petitioner had no opportunity to challenge the penalty and paragraph 20 of the attachment does raise claims of denial of due process and of the right to appeal imposition of the penalty. Those do not strike us as frivolous positions; indeed, they raise genuine issues as to material facts.” 2012 T. C. Mem. 46, at p. 7.

Bob wanted to be sent back for a face-to-face conference with Appeals (a standard delaying dodge), but Judge Halpern heads that off, telling Bob to save his arguments for the trial in Tax Court.

Lest Bob should feel too elated by his goal-mouth save on summary judgment, Judge Halpern shows him the Section 6673(a)(1) $25,000 frivolity penalty yellow card: “We are concerned that petitioner may have instituted this proceeding to delay collection of the penalties at issue. We caution petitioner to proceed with section 6673(a)(1) in  mind.” 2012 T.C. Mem. 46, at p. 9.

Or, Settled vs. Settled Right

Once again, Judge Mark Holmes takes on his colleagues in a “Son of BOSS meets Petalumas” case, Tigers Eye Trading, LLC, Sentinel Advisors, LLC, Tax Matters Partner, 138 T. C. 6, filed 2/13/12, a real eye-glazer.

Echoing his dissent in Randall J. and Karen G. Thompson, 137 T. C. 17, filed 12/27/11 (see my blogpost “The Great Dissenter”, 12/28/11), Judge Holmes takes on Judge Beghe, who writes the Tigers Eye decision, and Judges Colvin, Cohen, Halpern, and Goeke. Judge Halpern concurs “only to add some small weight to what, in the main, I consider to be a forceful and persuasive analysis by Judge Beghe.” 138 T.C.  6, at p. 128.

In brief, Tigers Eye and IRS stipulated a decision blowing up Tigers Eye, a phony tax shelter, and raining penalties on the partners. It’s another no-outside-basis case, with the partnership-level versus partner-level TEFRA gloss.

But then came Petalumas I,  II and III, with D.C. Circuit deciding that Tax Court has no jurisdiction even though IRS had conceded and stipulated jurisdiction. So the taxpayer moves to revise the stipulated decision.

No way, say the majority. They decide not to follow the Petalumas, because of factual differences and the decision of the US Supreme Court in Mayo Clinic (131 S. Ct. 704 (2011)), which requires the courts to follow regulations unless they fail the Chevron tests (Chevron USA Inc. v. Natural Res. Def. Council, 467 U.S.837 (1984). See my blogpost “Carpenter, Colony, Chevron and Mayo”, 4/26/11). For the next 125 pages, the majority upholds its jurisdiction and enforces the stipulated decision–no revision.

Judges Gale and Paris concur without opinion, and Judge Foley dissents, likewise without opinion, but Judge Marvel has her own dissent (in part II of which Judge Kroupa agrees, and Judges Gale and Paris agree in part), which goes off on the Section 6662(a) understatement or overvaluation penalties applying irrespective of inside or outside basis in a disregarded sham partnership.

Judge Wherry has a separate concurrence, based on what Tax Court should do when it disagrees with the relevant Circuit, and rebuking Judge Holmes as a grammarian.

Judges Gustafson, Vasquez and Morrison pass on this one.

But Judge Holmes, bless his contrarian heart, comes out swinging, despite Judge Wherry’s disdain for his grammatical take on Section 6231(a)(3), 138 T.C. 6, at p. 143.

To begin with, whether Tax Court likes it or not, the Petalumas control here: “In our landmark decision in Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), we held “that better judicial administration requires us to follow a Court of Appeals decision which is squarely in point where appeal from our decision lies * * * to that court alone.” (Fn. ref. omitted.) Golsen tells us not to bang our head against contrary appellate precedent, and we’ve consistently held that we must follow the precedent of the court that has appellate jurisdiction over a case.” 138 T.C. 6, at pp. 180-181 (Footnote omitted.)

Ignoring Golsen and its progeny will wreak havoc and engender endless appeals. “The tsuris this will cause us–where two circuit courts,  a few trial courts, the Department of Justice, and even the IRS (at times) all disagree with the position we’re taking–cannot possibly be worth it. Especially when it’s nothing more than a dispute about a complicated little bit of partnership-tax law–and not even substantive partnership-tax law, but partnership-tax-law procedure. And a point of partnership-tax-law procedure in a motion to revise a stipulated decision we entered in 2009. This was not the case to use to revisit Petaluma I: ‘[I]n most matters it is more important that the applicable rule of law be settled than that it be settled right.’ Burnet v. Coronado Oil & Gas Co., 285 U.S. 393, 406 (1932) (Brandeis, J., dissenting).” 138 T.C. 6, at p. 182. (Footnotes omitted.)

Judge Holmes sums it up: “In conclusion, I believe that we shouldn’t challenge the D.C. Circuit on the issue of our partnership-level jurisdiction over penalties any more than we should challenge it on the issue of outside basis as a partnership item.  Of all the routines in judicial gymnastics, few have a higher degree of difficulty than the reverse benchslap, and we’re trying for a combination double with our Opinion today.

“I’ll stand a safe distance off to one side, and respectfully dissent.” 138 T.C. 6, at p. 211. (Footnote omitted).

And because Judge Holmes writes cool footnotes, here’s the omitted footnote, footnote 17 at p. 211: “I’ll reiterate what I noted in Thompson: The Secretary should not view our Opinion as foreclosing the possibility that he could clear this area up much more efficiently through regulation than the Commissioner has been able to do through litigation. Thompson v. Commissioner, 137 T.C. at 244 (Holmes, J., dissenting).”

Oh yes, and Judges Kroupa and Thornton agree in part.

And, The Best Excuse Yet

Two recent Tax Court cases piqued my interest, picked from among the plethora of levy and lien timewasters. I can’t enjoy my vacation without a small retreat into blogging.

First, Lisa LaFlamme, 2012 T.C. Mem. 36, filed 2/6/12, and not just for the taxpayer’s name.  Lisa was a self-employed, licensed real estate agent in Florida during the year in question, while the boom was still booming and the bubble bubbling. Lisa made a hefty contribution to her pension plan, the Lisa K. LaFlamme Defined Benefit Pension Plan and Trust.

No question the contribution is deductible. But where? Lisa put the magic number on line 19 of her Schedule C, not line 28 of her 1040, and that caused the IRS to fire off a SNOD for tax and accuracy penalty.

Lisa claims she’s entitled because legislation enacted in 1962 allows self-employedniks to deduct pension contributions like corporations. True, but this is a case of “right law, wrong chapter”. Her contribution is not a Section 162 business expense for self-employment tax purposes, but rather an AGI adjustment for income tax purposes.

Thus, she owes self-employment tax on the amount of the contribution, but not income tax. Income tax is a Chapter One tax, SE is a Chapter Two tax, and Section 404(a)(8)(C) doesn’t help Lisa, although the language of the law (which see) looks like it does. Judge Vasquez says the legislative history makes it clear the Section 404(a)(8)(C) deduction is for income tax only, not SE. Judge Vasquez: “The legislative history suggests that the sec. 404(a)(8) rule is limited to the income tax, stating that the 1962 Act ‘allows contributions to retirement plans to be a deduction for income tax purposes’. S. Rept. No. 87-992, supra, 1962-3 C.B. at 310.” 2012 T.C. Mem. 36, footnote 7, at p. 9.

But Lisa acted reasonably and in good faith, obviously not having studied the legislative history of the 1962 statute. Lisa relocated from Connecticut to sunny Naples, FL (not so sunny today, as it’s been raining all night) years ago, and sells waterfront property. Chances are Lisa wasn’t born when Congress enacted the Self-Employed Individuals Retirement Act of 1962, and even I had barely escaped teenagerdom.

So Judge Vasquez gives Lisa a bye: “We find that petitioner had reasonable cause for the position taken on her return regarding the pension contribution and acted in good faith. See sec. 6664(c)(1). Petitioner, knowing that she was entitled to deduct her pension contribution, mistakenly believed she was entitled to deduct it on line 19 of her Schedule C which was labeled as ‘Pension and profit-sharing plans’. See sec. 1.6664-4(b), Income Tax Regs. (stating that a honest mistake of law may indicate reasonable cause and good faith).”

So Lisa, forget the penalty, but recompute your SE and income taxes in a Rule 155 jamboree. And preparers, look out, here be a trap for the unwary.

Now for my personal favorite in The Best Excuse for Late Filing sweepstakes. It comes from Steve and Lori Esrig, and is delivered by none other than the Judge that writes like a human being, The Great Dissenter and Ace Footnoter Judge Holmes. In the immortal and oft-quoted words of the late great Charles Dillon Stengel, “you could look it up”, specifically in 2012 T.C. Mem. 38, filed 2/7/12, under the name and style of Steven A. Esrig and Lori S. Esrig.

There are two cases rolled into one, because once Steve petitioned Case One, IRS fired off some fresh SNODs, so Steve and Lori petitioned Case Two. But you can read the tangled tale of Steve’s trademark dealings and his various unsubstantiated business activities; it’s the usual lack-of-substantiation case.

Until we get to the Section 6651(a)(1) late filing penalty. Steve and Lori were late by anything between one-and-a-half and four-and-a-half years in filing returns over the six-year span at issue. But Judge Holmes throws Steve and Lori a conditional rope: “Section 6651(a)(1) imposes an addition to tax for failing to timely file a tax return. A taxpayer can beat the penalty by showing reasonable cause, id., which here would mean proof that the Esrigs acted with ordinary business care and prudence and nevertheless were still unable to file as required, see United States v. Boyle, 469 U.S. 241, 246 (1985); sec. 301.6651-1(c)(1), Proced. & Admin. Regs.” 2012 T.C. Mem. 38, at p. 17.

But Steve and Lori drop the rope. Judge Holmes: “At trial Steven blamed the couple’s return preparer. He said that he’d asked his accountant to request extensions for all the years at issue, but his accountant missed all the deadlines because she had to serve a very long prison sentence for murdering her husband, and the person in her office who took over their account made a slew of mistakes.” 2012 T. C. Mem. 28, at p. 18.

That beats “the dog ate my homework” and “I was kidnapped by Martians” any day.

But Judge Holmes doesn’t buy this murder mystery. “We aren’t convinced. The Esrigs had no evidence to corroborate this lurid tale, and we therefore find that they had no reasonable cause for failing to timely file. Accordingly, we find Steven liable for the failure-to-timely-file additions to tax for 1998-2000 and both Esrigs liable for the failure-to-timely-file additions for the later years.” 2012 T.C. Mem. 38, at p. 18.

Good try, Steve and Lori.

When is interest on unpaid taxes abated? And what does it take for Tax Court to make abatement happen? Judge Goeke tells the story in John Hancock and Lynn Hancock, 2012 T.C. Mem. 31, filed 2/1/12.

John and Lynn got nailed on audit, but their accountant Mr. Biegler got them an offer from IRS that John and Lynn couldn’t refuse: no interest on the deficiencies if they signed at once. So John and Lynn signed the Form 4549 and went away happy.

Until IRS woke up to their mistake, and sent John and Lynn a demand for payment of interest. John and Lynn replied, asking that IRS honor their agreement. IRS replied by grabbing their tax refund to apply to the interest. So John and Lynn correspond with IRS, and IRS offers a partial abatement, but then backtracks.

IRS claims they mistook the date when John and Lynn were informed of the correct amounts of interest, and reduces the partial abatement. John and Lynn claim abuse of discretion, which IRS rejects, so John and Lynn petition Tax Court.

Judge Goeke: “Section 6404(e)(1)(A) provides that the Commissioner may, at his discretion, abate the assessment of interest on any deficiency in tax attributable, in whole or in part, to any unreasonable error or delay by an IRS officer or employee in performing a ‘managerial’ or ‘ministerial’ act.” 2012 T.C. Mem. 31, at p. 7. [Footnote and citations omitted.]

Finding Tax Court jurisdiction pursuant to Section 6404(h)(1), Judge Goeke examines the managerial and the ministerial: A ‘managerial act’ is an administrative act which occurs during the processing of a taxpayer’s case and involves the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel. ‘Ministerial acts’ include procedural or mechanical actions not involving the exercise of judgment or discretion that occur during the processing of a taxpayer’s case after all prerequisite action has taken place.

“Section 6404(e) applies only after the Commissioner has contacted the taxpayer in writing about the deficiency, and this Court will give due deference to the Commissioner’s use of discretion.” 2012 T.C. Mem. 31, at p. 8. [Citations omitted.]

That said, the taxpayer bears the burden of proof. “To qualify for abatement of interest, the taxpayer must: (1) identify an error or delay by the IRS in performing a ministerial or managerial act; (2) establish a correlation between the error or delay by the IRS and a specific period for which interest should be abated; and (3) show the taxpayer would have paid his or her tax liability earlier but for such error or delay.” 2012 T.C. Mem. 31, at p. 9.

If IRS misinforms the taxpayers about their liability, that’s ministerial. And IRS agrees they did misinform John and Lynn. But did John and Lynn provide answers to the three questions: Did they identify the error? Did they tie the error in to the specific period for which they seek abatement of interest (and seeking 100% abatement won’t get it)? Finally, could John and Lynn have paid the liability but for the error?

“Petitioners are not merely searching, groundlessly, for an exemption from interest, nor have they contributed to the many errors by respondent. Instead, petitioners validly seek an interest abatement on account of respondent’s professed errors.

“Petitioners’ inartful attempt to expressly articulate the period for which interest abatement is warranted is a direct function of the confusion and inconsistency which pervaded respondent’s actions following petitioners’ execution of the Form 4549. Initially, respondent appeared to agree that no interest accrual was warranted on petitioners’ deficiencies when he approved the executed Form 4549. In an unexplained change of posture, respondent then issued a notice and demand to petitioners on November 3, 2008, stating that they owed interest for their 2005 and 2006 tax years. Petitioners, continuing to rely on the executed Form 4549 In an unexplained change of posture, respondent then issued a notice and demand to petitioners on November 3, 2008, stating that they owed interest for their 2005 and 2006 tax years. Petitioners, continuing to rely on the executed Form 4549 and uncertain as to the propriety of the notice and demand, subsequently wrote two letters to respondent seeking clarification of respondent’s position and also requesting that respondent abide by the terms of the executed Form 4549. During the period in which petitioners waited for respondent’s official response to their letters, respondent applied a tax refund from petitioners’ 2008 tax year to their tax liabilities at issue, satisfying the liabilities in full. It was only at this point that petitioners realized that respondent had disregarded what petitioners perceived as the clear calculations in the executed Form 4945 and instead relied on the calculations in the November 3, 2008, notice and demand. Respondent’s position was altered twice thereafter, further complicating matters.

“Given the confusion engendered by respondent’s actions, we find that petitioners’ request for interest abatement is framed by the period following the their receipt of Form 4549 and ending with the payment in full of the liabilities on April 15, 2009. Respondent’s posttrial brief underscores this point by conceding that he was in error from the “date the erroneous interest amounts were provided to the taxpayers until the date on which respondent provided corrected interest amounts.” We find that the date respondent unequivocally provided corrected interest amounts was April 15, 2009.

“Thus, petitioners have satisfied their burden.” 2012 T.C.Mem. 31, at pp. 12-13. [Footnote omitted.]

But what about paying the tax? “The argument that petitioners did not present evidence of their ability to pay the interest liabilities, irrespective of respondent’s error, applied equally to the conceded period; yet respondent accepted that he abused his discretion in failing to abate interest for the period from June 19 to November 3, 2008. As respondent has abandoned the argument in part, we find as a corollary that he abandoned it in whole. We need not address it further.” 2012 T.C. Mem. 31, at pp. 14-15.

John and Lynn raised equitable estoppel, that is, “. . . a judicial doctrine that ‘precludes a party from denying his own acts or representations which induced another to act to his detriment.’” 2012 T.C. Mem. 31, at p. 16.

But Tax Court’s jurisdiction is limited,  so there will not be any excursion around equitable estoppel. Taxpayers must show affirmative misconduct by IRS, and even more, that the misconduct results in serious injustice and the public interest will not be injured by the estoppel sought. Here, that’s not the case.

But the taxpayers win this one.