Doesn’t get you a charitable deduction this time, says Judge Dawson, in Upen G. Patel and Avanti D. Patel, 138 T.C. 23, filed 6/27/12.

Upen and Avanti wanted to demolish the house on land they bought in Vienna, VA, up the road a piece from us here at the NSTP Summer Session. The Fairfax County Firefolks had a program whereby they would burn down your house (with your consent and your mortgagee’s, of course) to train their firefighters. Upen and Avanti wanted the house removed anyway, so they handed the keys to the firefolks and told them to do their thing, claiming a charitable deduction.

IRS invokes the Section 170(f)(3)(A) amendment to Section 170, the “no partial interest deduction” rule, claiming the most that Upen and Avanti gave the Vienna Firefighters was a license to go onto their land and burn down a structure for which (a) Upen and Avanti had obtained a demolition permit and (b) obtained construction financing for a brand-new house and (c) in which Upen and Avanti never lived.

The house and the land are inseparable, under Virginia law. Judge Dawson: “Where a taxpayer contributes to a charity an interest in a building that is part of the land under State law but retains all title to and interest in the remaining land, the taxpayer has donated less than his entire interest in the land.  The taxpayer will not be allowed a charitable contribution deduction unless the donated interest falls within the exceptions of section 170(f)(3)(B).

“In the case at hand, the house was attached to the land and was conveyed to petitioners along with the land when they purchased the Vienna property.  Under the common law and the laws of Virginia, the house was part of the land that is the real estate we refer to as the Vienna property.  Petitioners’ purported contribution of the house to FCFRD [the firefighters] was a contribution of less than their entire interest in the Vienna property.” 138 T.C. 23, at p.19.

So, no charitable contribution for Upen and Avanti.

But they dodge penalties, because when they filed their return, the law had not been settled as it is now, and old pre-amendment precedent existed that might have justified their position.

In Bob Dylan’s words from his 1970 ballad, “You’ll not see nothin’ like the mighty Quinn”, but hers is a sad tale, told by Judge Kroupa, in Jacynthia Quinn, 2012 T.C. Memo. 178, filed 6/27/12.

Jacynthia (great name) was a longtime IRS tax compliance officer, still employed by IRS at time of trial. But Jacynthia went rogue, fabricating medical and dental deductions and inventing charitable contributions. I won’t go into the sorry details, the blatant forgeries and continuous efforts to thwart the resolution of this matter.

Her husband testified against her, as did officers of the various charities to which Jacynthia claimed she made contributions and proffered altered documents to substantiate. She was unable to spell the name of the doctor to whom she claimed she had paid substantial medical bills.

And she claimed dependent exemptions for dependents who clearly weren’t.

In short, there was clear and convincing evidence enough for the imposition of civil fraud.

It’s sad that someone would throw away their career for $17,000 of deductions. And sadder that it would be one sworn to uphold the law.

I’ll be down in Virginia for the next few days, at the NSTP Tax Round-up, getting some CPE hours for my EA (which still hasn’t been renewed, although IRS got my money timely).

Meantime, no interesting cases, just a Memo on a tax protester, and two 7463s, one a single mom whose testimony was credible enough to sustain her entitlements and the other an innocent spouse whose version of the “most significant” issue upon which she prevailed for her Section 7430 expense reimbursement didn’t jibe with Judge Marvel’s view.

Nothing novel here.

I’ll try to find something interesting to blog from Ol’ Virginny.

Doesn’t Matter, She Was In Too Deep

So sorry, says Judge Marvel to Sari Diehl, in Sari F. Deihl, 2012 T.C. Mem. 176, filed 6/21/12, only partial innocent spouse for you, 50%.

It’s the usual cocktail of facts, which occupies 37 pages of Judge Marvel’s prose, but I’ll spare you. The facts of your case will vary at least as much as your mileage.

But what’s interesting is the “blended” approach Tax Court will take post-Notice 2012-8, 2012-4 I.R.B. 309, which revised the old standby Rev. Proc. 2003-61, 2003-2 C.B. 296 (see my blogpost “Innocence Is Bliss,” 1/6/12).

Now both parties want Tax Court to use Notice 2012-8 standards and not the old Rev. Proc. 2003-61. Tax Court held a conference call in January on the subject, and the parties were agreed.

But Judge Marvel isn’t. “…in Sriram v. Commissioner, T.C. Memo. 2012-91, slip op. at 9 n.7, we took the position that we would ‘continue to apply the factors in Rev. Proc. 2003-61, 2003-2 C.B. 296, in view of the fact that the proposed revenue procedure is not final and because the comment period under the notice only recently closed.’ Additionally, because our holding in Sriram did not turn on any single factor as revised in the proposed revenue procedure, we called attention in the opinion to the effect, if any, of a revised factor only to the extent we deemed it necessary for clarity. Id. We adopt a similar approach here. We shall decide whether petitioner is entitled to relief under section 6015(f) by considering all of the relevant facts and circumstances, evaluating them through the prism of Rev. Proc.  2003-61, supra, and noting where appropriate how the analysis used in Rev. Proc. 2003-61, supra, would change if the proposed revenue procedure in Notice 2012-8, supra, had actually been finalized.” 2012 T. C. Mem. 176, at p. 29.

But, of course, facts and circumstances rule (Sir Ed Elgar really needed to write a march using that name). So preponderance-of-evidence, credibility of witnesses and de novo standard and de novo scope of review bring Judge Marvel to the same conclusion, whatever yardsticks the parties want to use. “In any event, our approach to deciding whether petitioner qualifies for relief under section 6015(f) and our conclusion remain the same regardless of whether we apply the analysis of Rev. Proc. 2003-61, supra, or adopt the approach proposed in Notice 2012-8, supra.” 2012 T. C. Mem. 176, at p. 29.

Sari’s tax problems stemmed from two corps she and her late husband founded and owned. She was enough involved in operations and management so her ownership wasn’t merely nominal. Her claimed abuse wasn’t substantiated by hospital or police reports, and her son’s testimony that Daddy was a bad actor isn’t enough, as Sonny stands to gain a lot of cash if Mommy’s tax problems go away.

So either way, sorry, Sari.

There’s a Lawsuit

So said Addison Mizner, and Judge Goeke is prepared to go even further, because there’s a lawsuit even though there wasn’t a will until thirteen years after the testatrix died; at least so far as anyone knew.

That’s the story behind Estate of Alfred J. Richard, Deceased, Gary H. Richard and Peter C. Richard, Co-Executors, 2012 T. C. Mem. 173, filed 6/20/12.

Alf was the father, Gary and Peter the sons, and Victoria was mom and Mrs. Alf. Victoria exits this life in 1997, holding 140 Class A preferred shares of the family’s holding corp, par value $1000 each, 8% non-cumulative, voting, convertible. Victoria also had a secret; she had made a will back in 1991, but nobody knew about it (they claim), there was never probate or a 706 filed, and as far as anyone knew Vicky never had a will.

Vicky’s will said her sons were execs, and should sell or redeem the shares and pay out to her sons and grandkids. The will had sat in a lawyer’s vault, and nobody tipped off the kids that there was a will, much less that they were named execs.

So since all Alf and Vicky’s other property was held as joint tenants with right of survivorship (last one standing takes all), when Alf buckets in 2004, his execs list 740 shares of Class A on the 706, when Alf really only had 600 shares.

There’s also a minor issue between the execs and IRS. The execs valued the stock at $1000 per share, or $740,000, but IRS claims “… the shares were worth $142,203,000 because the 740 preferred shares constituted over one-third of the voting shares in A.J. Richard & Sons, sufficient to block any major change from occurring to the corporation.” 2012 T. C. Mem. 173, at p. 6, footnote 8.

Oh yes, and IRS tacks on substantial undervaluation penalty, so we’re talking $68 million in tax and $27 million in penalty. So if Alf didn’t have the 140 shares, the bite would be about 19% less if the 600 shares he still had could stymie any major change, but  a lot less than that if they couldn’t.

IRS argues that Alf exercised dominion over the 140 shares as if they were his, but that doesn’t fly; there were no shareholder meetings so he never voted the shares, no dividends  were paid, Alf never tried to transfer the shares out of Vicky’s name (whether to himself or anybody else), and though IRS argues that no one would have stopped him if he did, that’s not enough. “Might have” doesn’t get it.

Under applicable State law (Florida, where else?), title vests per will at date of testatrix’s death,  even if no one knows about the will. And the local probate court admitted Vicky’s will as soon as the execs found it and filed it. That of course isn’t the end, as State court decisions don’t bind IRS even on State law until the State’s highest court has affirmed.

But even though Tax Court could look de novo, Alf did nothing contrary to Vicky’s title. IRS lambastes the execs for failing to include Vicky’s car and jewelry in her estate tax return, failing to redeem or sell the stock (although they claim they tried to redeem but the Corp said ‘no’), and for not holding shareholder meetings. But not including the car and jewels doesn’t negate the fact they did include the 140 shares as soon as they got Vicky’s will probated; as for failing to redeem, that may raise a claim for breach of fiduciary duty, but that’s for another court and another day. Finally, closely-held family corporations don’t have Warren Buffet style annual meetings, and Tax Court finds nothing nefarious in the fact that no meetings were held.

IRS claims that, under FL law, there’s a two-year statute of limitations on claims against a decedent’s estate, and that ran on Alf’s estate years ago. But this claim arose after Alf’s death, it was the execs and not Alf who included the 140 shares in Alf’s estate, so the FL statute doesn’t apply.

And the new will is cogent proof why the execs aren’t bound by the 706 they signed, including the 140 shares in Alf’s estate.

So Vicky’s estate has the 140 shares.

Takeaway- All preparers, please please please tell your clients who have wills to let some trusted person know where they are.

And lawyers, look in your vaults occasionally; you never know what you might find there.

Or, How to Make It Look Like Debt

That was the task of the advisors and consultants when ScottishPower, supplier of megawatts to Scotland, England and Wales, went shopping for a US public utility and bought PacifiCorp, supplier of “electricity and energy-related services to retail customers in several States, including Oregon, Utah, Washington, Idaho, Wyoming and California.” 2012 T.C. Mem. 172, at p. 3.

Part of the deal involved floating-rate and fixed rate instruments, which the Scots wanted to be debt (so that their American subsidiary could deduct interest) and which IRS wanted to be equity (so they couldn’t), in NA General Partnership & Subsidiaries, Iberdrola Renewables Holdings, Inc. & Subsidiaries (Successor in Interest to NA General Partnership & Subsidiaries), 2012 T. C. Mem. 172, filed 6/19/12, with Judge Kroupa, untangler of corporate cats’-cradles, at the switch.

The Scots saw PacfiCorp floundering, its stock depressed and its management seeking a suitor. The Scots, ever alert to a canny manoeuvre and knowing PacifiCorp had a solid core business, set up an acquisition partnership, swapped stock to acquire PacifiCorp, and unloaded some of PacifiCorp’s Australian holdings, which were diverting attention from the core business.

The acquisition entity funded the acquisition of ScottishPower stock to swap for PacifiCorp stock in the merger with floating-rate and fixed rate paper.

The Scots did it right: fixed maturity dates, fixed due dates for interest, stated rate of interest, default and acceleration of principal provisions, prepayment and call provisions.

Of course, the subsidiary missed a couple of due dates for interest while some regulatory issues were being addressed, and a couple of payments were made by way of journal entries without cash changing hands.

Applying Ninth Circuit learning, Judge Kroupa knocks out IRS’ $188 million deficiency.

“The Court of Appeals for the Ninth Circuit considers eleven factors to determine whether an advance is debt or equity. These factors include (1) the name given to the documents evidencing the indebtedness; (2) the presence of a fixed maturity date; (3) the source of the payments; (4) the right to enforce payments of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) ‘thin’ or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of ‘dividend’ money and (11) the corporation’s ability to obtain loans from outside lending institutions. No one factor is decisive, and the weight given to each factor depends on the facts and circumstances.  Our objective is not to count the factors, but rather to evaluate them.” 2012 T.C. Mem. 172, at pp. 16-17 (Citations omitted).

Let’s look at the easy ones; 1, 2 and  4 go for the Scots; 9 goes for the IRS.

Number 7 might have been a cliffhanger, because of the tax benefit if the notes are debt, but Judge Kroupa says that’s all right: “Indeed, tax considerations permeate the decision to capitalize a business enterprise with debt or equity. Interest paid on indebtedness is deductible while no deduction is allowed for dividends paid. Moreover, ScottishPower’s desire to obtain interest expense deductions in capitalizing NAGP [the acquisition sub] with debt does not show that the parties lacked the requisite intent to enter into a debtor-creditor relationship, as respondent [IRS] implies. If anything, it shows the opposite.” 2012 T.C. Mem. 172, at pp. 25-26.

Number 5 goes for the Scots; they can’t increase their management participation over the acquisition sub, because they already own and control 100% of its voting power. Not even Max Bialystok can beat that.

As for Number 6, IRS says the notes don’t prohibit subordinate or senior financing, and the acquisition sub did get a credit line from Royal Bank of Scotland, to which ScottishPower was subordinate, although that was paid back. Doesn’t matter, says Judge Kroupa: “We are not persuaded by respondent’s argument. We have recognized that certain creditor protections are not as important in the related-party context. For example, we have previously found that a parent’s 100% ownership interest in its subsidiary adequately substituted for a security interest, or at least minimized its importance. Similarly, ScottishPower as NAGP’s sole shareholder had the power to prevent NAGP from taking on any additional debt, including senior debt.” 2012 T. C. Mem. 172, at p. 23 (Citation omitted). Number 6 goes for the Scots.

On Number 3, source of cash to pay debt, the Scots call on expert Israel Shaked, who says the projected cash flow from PacifiCorp’s operations plus the Australian sales proceeds would be sufficient to pay off the notes at maturity. IRS goes with Robert Mudge, who says there wouldn’t be enough cash, because Robbie assumes the Australian cash will be a dividend, so he’s out of the money, and Israel Shaked brings home the bacon for the Scots. There’s also a minor regulatory glitch from Oregon PUC about paying out too much cash, but Judge Kroupa says that’s de minimis as it only applies to Oregon, and the rest of the territory has no such restriction.

Number 8 finds Mr. Mudge short of amperage once more, while Israel Shaked again lights the lamp. While maybe the acquisition sub wouldn’t have an S&P “A” rating, it still would get a “B”, and that’s not too shabby; at least, not so shabby as to make repayment remote.

Bottom line: Scots win it.

Takeaway: Good planning and good expert testimony carry the day.

And basis for his conclusion? If he says so, Tax Court must consider whether it’s persuasive, but cannot disregard it entirely. Thus spake the Second Circuit, in Scheidelman v. Com’r, No. 10-3587, decided 6/15/12.

Thanks to Joel Miller, Esq., for sending this along.

Huda Scheidelman owns another one of those precious facades. She’s in a historic district and grants a historic structure preservation facade easement, enabled by our old acquaintance the National Architectural Trust, and gets one Michael (“Iron Mike”) Drazner, a qualified appraiser, to give her the magic number, the diminution of value caused by the easement, so she can take a whopping charitable deduction.

Are you paralyzed with shock when Iron Mike comes in at 11.33% of the building’s free-and-clear value? If so, you haven’t been paying attention. Huda’s easement was granted in the heyday of the famous “Primoli Article”. See footnote 6 in Scheidelman,  where Ch. J. Jacobs states: “‘Facade Easement Contributions’ by Mark Primoli, was written as part of an IRS program focusing on specialized areas of tax law. The Primoli article, in turn, had relied upon a 1994 IRS ‘Audit Technique Guide,’ used to train tax examiners but not intended to set IRS policy. In 2003 both the Audit Technique Guide and a revised version of Primoli’s article omitted any reference to the ten to fifteen percent range for fear the numbers were being misconstrued.” Scheidelman, at p. 14, footnote 6.

Poor old Primoli opened the floodgates, and everyone assumed ten to fifteen percent was an unchallengeable safe harbor, until IRS played Admiral Farragut, damned the Primoli torpedoes, and torpedoed every easement they could find (I’ve done about five blogposts based upon the torpedoing). I expect poor Mark Primoli is now auditing 1040-EZs in Point Barrow, AK.

So Iron Mike does his thing, which Ch. J. Jacobs and colleagues finds complies with the Regulations as then in effect. “The Tax Court concluded that there was no method of valuation because ‘the application of a percentage to the fair market value before conveyance of the facade easement, without explanation, cannot constitute a method of valuation.’ We disagree. Drazner did in fact explain at some length how he arrived at his numbers. For the purpose of gauging compliance with the reporting requirement, it is irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied — it remains a method, and Drazner described it. The regulation requires only that the appraiser identify the valuation method ‘used’; it does not require that the method adopted be reliable. By providing the information required by the regulation, Drazner enabled the IRS to evaluate his methodology.” Scheidelman at pp. 15-16 (Citation and footnote omitted).

Anyway, also in compliance with the Regulations as in effect when Huda filed her 8283s (two of them, and one of them she didn’t sign), she provided what information was required. It might have been nice if Huda put it all in one neat package, but anyway: “Scheidelman submitted two Form 8283s, which together contained the information required. In support of her deduction, Scheidelman submitted the Form 8283 completed by Drazner and the Trust as well as a supplemental Form 8283 filled out (but not signed) by her tax preparer, John Samoza. The second Form 8283 contained the information omitted from the Form 8283 completed by the Trust and signed by Drazner and the Trust.

“The second Form 8283 was not signed by Drazner or the Trust. But the two forms were both attached to Scheidelman’s tax return and together contained all of the information and signatures required by Treasury Regulations. The required information and signatures were thus dispersed in two forms submitted together, rather than gathered in a single form; but that is the most technical of deficiencies, which is properly excused on two grounds: ‘reasonable cause,’ see 26 U.S.C. § 170(f)(11)(A)(ii)(II); and the doctrine of substantial compliance, see Bond v. Comm’r, 100 T.C. 32, 42 (1993).”Scheidelman, at pp. 20-21.

So when IRS claims the appraisal is useless, because lacking method and basis, that’s not the point. Ch. J. Jacobs: “The Commissioner [IRS] may deem Drazner’s ‘reasoned analysis’ unconvincing, but it is incontestably there. Treasury Regulations do provide substantive requirements for what a qualified appraisal must contain. Some would seem to be inapplicable, and others are expressly considered by Drazner. And of course, the Treasury Department can use the broad regulatory authority granted to it by the Internal Revenue Code to set stricter requirements for a qualified appraisal. Moreover, the Commissioner could review the Drazner appraisal in the context of a considerable body of data. Around the time Scheidelman was audited, the IRS had undertaken a project in which it reviewed about 700 facade conservation easements, about one-third of them all. See Internal Revenue Service Advisory Council 2009 General Report, available at http://www.irs.gov/taxpros/article/0,,id=215543,00.html.

“In sum, the Drazner appraisal accomplishes the purpose of the reporting regulation: It provides the IRS with sufficient information to evaluate the claimed deduction and ‘deal more effectively with the prevalent use of overvaluations.’ Hewitt v. Comm’r, 109 T.C. 258, 265 (1997), aff’d, 166 F.3d 332 (4th Cir. 1998) (per curium)[sic]. And since the Commissioner’s bottom line is that the donation had no value at all, it is hard to see how any defect in the appraisal would matter.” Scheidelman, at pp. 18-20 (Footnote omitted; but read it, it’s got some items from the IRS shopping list for appraisals.)

So Iron Mike’s appraisal must be reconsidered by Tax Court, although they can throw it out. And Huda’s cash deduction for what she paid National Architectural Trust wasn’t payment for services, because the services were performed and the easement benefited NAT, so no quid pro quo, and her deduction is allowed.

Gotta love that unguided Congressional largesse. Oh, and by the way, the correct spelling is “per curiam”.

Old-time movie fans will remember S. J. Perelman’s witty rejoinder from the cigar-laden lips of Groucho Marx, in the 1932 classic “Horsefeathers”:

Receptionist: The Dean is furious! He’s waxing wroth!

Groucho: Is Roth out there, too? Tell Roth to wax the Dean for a while.

Well, a couple who wanted their Roths to wax great found themselves on the wrong end of an excise tax for excess contributions to their Roth IRAs in Steven W. Repetto and Gayle F. Repetto, et al., 2012 T.C.Mem.168, filed 6/14/12, with Judge Marvel doing the waxing with a hefty tax.

This was one of the Notice 2004-8, 2004-1 C.B. 333, Abusive Roth IRA Transactions. The taxpayer takes a pre-existing business (here the Repettos were homebuilders), creates sibling entities under common ownership and control (here corporations supposedly providing back-office services), puts the corporate stock into their Roths, and sends down the dividends.

Mr R needed a pastime after retiring from Big Blue, and Mrs R was an engineer looking for new horizons. So they teamed up with a homebuilder, learned the business, and started running it themselves when their mentor became ill.

Their mentor turned them onto an accountant and a tax lawyer, who set up the corporate structure. The Rs already had a corporation in place for asset protection purposes. When the attorney told them that the siblings could be owned by their Roths and channel the dividends to the Roths, Mr R cogently e-mailed said attorney: “We do not meet the rules for a ROTH IRA as our Adjusted Gross Income is to [sic] high. I understand that we can pay a fine as you explained but would our IRA be fraudulent?” Mr. X replied “No”. 2012 T.C. Mem. 168, at p. 10. (Name omitted.)

Well, that e-mail was enough to torpedo the Rs’ defense to the Section 6662A reportable transaction understatement penalties.

Before that, Rs try a Section 7491 burden-of-proof shift, but that fails, since the excise tax is a Subtitle D, and the shift only works for Subtitle A (income) or Subtitle B (estate and gift) taxes. And as usual, Judge Marvel does the preponderance-of-evidence dodge and claims burden of proof irrelevant as to the Subtitle A income tax issues (namely, deductions that Rs’ corporations took and their corporate medical reimbursement plan).

Now a Roth IRA can own C Corp stock, and many do. But the C Corps have to have a substantial business purpose (note that the business activity test of Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943) isn’t invoked here, and doesn’t help, because the Rs did exactly what they did before the C Corps were created, and ignored whatever contractual arrangements were in place; see my blogpost “Even a Little Substance Matters”, 5/19/11). And the only purpose the sibling C Corps served was to funnel money into the Roths, above the AGI limit, which the Rs clearly exceeded.

Rs tried to argue, relying on Hellweg and Ohsman (see my blogpost “Foolish Consistency,” 5/5/11), that IRS was inconsistent in income tax and excise tax treatments, and therefore the excise tax must fall. No, says Judge Marvel, while IRS didn’t do a Section 482 reallocation among relateds, IRS did knock out the deductions Rs took for payments from its parent to the sibs, and that’s enough to be consistent.

But IRS went too far in assessing penalties, throwing in every item it could find, and not all fit. For details, read the decision.

Takeaway: Let your Roth wax, but keep to the rules.

 Can Section 269 Ever Apply to a Sub S Corp?

Although I can’t think that this is a question that has kept any of us awake on any night in recent memory, Judge Swift deftly ducks it in Kevin H. Love and Ronda J. Love, et al., 2012 T. C. Mem. 166, filed 6/13/12.

Kev and Ronda aren’t even mentioned outside the caption, although their facts parallel those of Mark McKay and Christine A. Beck-McKay. So as Mark and Christine and Kevin and Ronda, and a lot of other people, all stipulate to the necessary facts and consolidate, Judge Swift goes with the flow.

Taxpayer runs a couple of successful fast-food franchises in Utah. They create two Sub S corps, one to run the deep-fryers and the other to do back-office (payroll, taxes, bookkeeping). They start a profit-sharing plan, but that doesn’t do too well, so they flip it into an ESOP, and create a Non-Qualified Deferred Comp plan for the heavy hitters, which gets paid ahead of the ESOP contributions. Of course, the deferred comp heavies get the cherries and the ESOP gets the pits, to the extent of $3 million deferred for the one-percenters, and a hundred grand for the lackeys.

Congress wakes up, and for the year at issue amends the IRC to impose monumental excise tax, penalties and flogging around the fleet, if the heavies don’t disgorge the deferred comp, pay tax, and restructure the ESOP so as to give the lackeys something more.

Restructuring is a pain, so the heavies kill the ESOP, and go back to the profit-sharing plan of yesteryear. In the process, their Sub S takes a $2.9 million paper whack when it buys back the Sub S stock formerly in the ESOP. The heavies split the year in question in two halves. In half one, the heavies get the $3 million ordinary from the Deferred Comp distribution; in half two, the Sub S’s $2.9 hit creates a loss that flows through to the heavies.

The heavies increase their basis in the Sub S by throwing enough of their cash into the sub S to take the loss in half two.

IRS is not amused. They first allege Section 482 and Section 382 (reallocate income and deductions among related entities for income, and reduce loss to basis in sub S pre-contribution), but they drop this (why, I don’t know; not a bad argument, as the heavies are on all sides of this deal), but then ring in Section 269, the old tax-loss corporation rule. You can’t buy a losing entity for the principal purpose of laying off your winnings.

Judge Swift: “Section 269 applies only if tax evasion or avoidance is the principal purpose for the acquisition. In the context of section 269, ‘principal purpose’ means that the evasion or avoidance purpose must exceed in importance any other purpose. In considering what is the principal purpose, it is appropriate to aggregate all tax avoidance purposes and compare them with the aggregate business purposes for the acquisition.” 2102 T. C. Mem. 166, at p. 18 (Citations omitted.)

The heavies have the burden of showing their principal motivation was not tax avoidance. This they do, by showing that the new requirements for the ESOP were administratively burdensome, and the old management structure was inefficient and costly. Section 1377 allowed the half-year split, because of the management changes required by the new ESOP rules.

And the heavies really put $2.9 million of cash into the Sub S to build up their basis and take the loss. See my blogpost “Winning the Paper Chase”, 6/6/12; if you put in something of value, you can take the loss.

Also, there’s no caselaw on the application of Section 269 to Sub S corps. But Judge Swift isn’t making any, either: “Having decided the factual issue before us in favor of petitioners, we need address neither the legal issue petitioners and respondent raise (whether section 269 ever may be applied to a taxpayer’s acquisition of the stock in an S corporation), nor the penalties determined by respondent.” 2012 T. C. Mem. 166, at p. 26.

Too bad; I can think of a scenario where Section 269 would apply. My Sub S is sinking fast, with heavy-duty loss carryforwards. I can’t use the losses. Your sub S is a home run, but it’s generating all ordinary income, and you’re in max bracket. You buy my Sub S, whose business has nothing to do with your Sub S’s business, at a deep discount. At least I have some cash.

You merge the two Sub Ss, but your combined basis is too low to use all the losses I sold you. But next year will be even better, and you can contribute enough cash to your Sub S to take all the losses I sold you.

What do you think?

 Or, Chutzpah in the First Degree

The Yiddish word chutzpah (the “ch” is gutteral, like clearing your throat, not hard as in “chew”) means impudence, nerve, gall. The classic example is the murderer of his parents who pleads for mercy because he is an orphan.

Joe Alfred Izen, Jr., Esq., gives a lovely example of this endearing trait in Karen L. Cooley, 2012 T.C. Mem. 164, filed 6/11/12. And the long-suffering jurist confronted with Joey A’s attempted raid on the Treasury is none other than The Great Dissenter, the Judge who writes like a human being, Judge Mark V. Holmes  (even if he is ignorant of the partitive genitive; see 2012 T.C. Mem. 164, at p. 11, where he perpetrates the following: “couple rounds of briefing”; c’mon, Mark, do you have a cup coffee at breakfast?).

Karen happens to be Mrs Joey A, and works in his law office, although she has a post-nup with Joey A saying all money separate, files separately, and claims to be an IC. She sent in two checks on the same day, one to pay for one year’s tax and the other for an installment of her estimateds for the next. But on voucher two and check two, she reversed two numbers of her SSAN.

IRS struggles with this, gets it wrong, and sends a SNOD. Karen appeals, and the IRS tries to figure out what happened. Joey A shows IRS the front (but not the back) of check two. The back, of course, shows the wrong SSAN, which IRS encoded on the check based on the wrong information on the voucher.

Now voluntary payments can be applied as taxpayer directs (involuntaries can’t necessarily be). So when Appeals still shows Karen short, she petitions, and is represented by the redoubtable Joey A.

On eve of trial, Joey A. produces copies of voucher, and front-and-back of check two. IRS immediately drops the case, seeing they cashed the check, and corrects the error Karen caused.

Now Karen wants the USA to pay Joey A $30K in legal fees, claiming she prevailed. Nice, huh?

But Karen doesn’t have a retainer agreement with Joey A, or periodic billing statements, or anything that shows a legal obligation. Judge Holmes: “The single billing statement that we have is dated only days before Mr. Izen filed his motion. We find, as a result, that he prepared it solely for the purpose of the motion and that it does not reflect any obligation by Ms. Cooley to pay Mr. Izen $20,000 or $30,000 for this $2,000 dispute–an obligation we would be hardpressed without very persuasive evidence to think any but the unusually innumerate or incorrigibly stubborn would assume. The fact that Ms. Cooley and Mr. Izen entered into a postnuptial agreement and that she says she has paid him for legal services in the past is just not enough to prove she has a legal obligation to pay him in this case.” 2012 T. C. Mem. 164, at p. 16. (Citation omitted.)

Anyway, IRS was substantially justified, because neither Karen nor Joey A showed IRS the back of check two. “The reasonableness of the Commissioner’s position turns on whether he knew or should have known, based on the available facts and circumstances and the legal precedents relating to the case, that his position was invalid when he adopted it. A significant factor in making this determination is whether the taxpayer presented all relevant information under her control.” 2012 T.C. Mem. 164, at p. 19-20. (Citations omitted.)

Karen didn’t. And her designation of how her payments were to be applied was imprecise. And IRS did the right thing by dropping the case as soon as they had all the relevant facts, “professionally and honorably”, says Judge Holmes, 2012 T.C. Mem. 164 at p. 24. So IRS’s position was “substantially justified” at the relevant times, even if later their position was shown to be wrong.

So no payday for Joey A. But Joey A is quite a card. And he and Karen are quite a team.