But Some Can

I was at the Bureau of National Affairs Advisory Committee meeting October 25, talking to my old friend Joel E. Miller, Esq., about the recent spate of scenic easement cases, and the Whitehouse decision, 139 T. C. 13, filed 10/23/12 (see my blogpost “Chipping Away the Facade – Part Deux”, 10/24/12).

Between the Coca Cola and Cracker Jack that preceded the meeting, Joel mentioned that he had brought to Judge Halpern’s attention an arithmetic flub in the decision. Taxpayer had overstated the valuation by 400%, not that the taxpayer’s valuation exceeded the actual valuation by 400%.

I had missed the arithmetic error when I blogged the decision, and said so. I told Joel that lawyers can’t add, so I wasn’t surprised.

But conscientious Judge Halpern has amended his decision to correct the errors in an Order, Docket No. 12104-03, filed 10/31/12. He doesn’t credit Joel, so I’ll take the liberty of doing so now.

Loren G. Rice, as Trustee of what looks like a self-settled trust, wants IRS to stay away and mail her a timely NFTL, but she gets neither from Judge Wells in Loren G. Rice Trust, Loren Georgette Rice, Trustee, 2012 T. C. Memo. 301, filed 10/31/12, as Tax Court comes back on stream after the Sandy-induced layoff.

Loren claimed her trust had a $90K refund coming and got the check, but IRS determined an overstatement of withholding and gave Loren a Form 3552 Notice of Tax Due, hand-delivered to her at her place of employment, and on the same day filed a NFTL. Loren didn’t get her five-day notice; that didn’t show up for two weeks.

Loren claims the NFTL is invalid because she didn’t get the five-day notice mandated by Section 6320. Judge Wells: “‘The validity and priority of a NFTL is not conditioned on notification to the taxpayer pursuant to section 6320. Therefore, the failure to notify the taxpayer concerning the filing of a NFTL does not affect the validity or priority of the NFTL.’ See sec. 301.6320-1(a)(2), Q&A-A12, Proced. & Admin. Regs. Ms. Rice has not challenged the validity of this regulation. Accordingly, we conclude that respondent’s failure to provide notice within the five-day period after filing the NFTL does not affect its validity.” 2012 T. C. Memo. 301, at p. 11. Maybe she should have; or maybe, with $90K on the table, she should have hired a lawyer. See my blogposts “Hire A Lawyer”, 8/13/12, and “Heavy Weather – for Weatherly”, 8/26/11.

But Loren grouses about the visitation from the revenue agent to drop off the Form 3552 Notice of Tax Due at her place of employment. She claims Section 6304(a)(2) prohibits IRS from coming to her workplace if her employer objects.

True, but IRS has to know that visits to the taxpayer’s workplace are out of bounds. Judge Wells: “There is no evidence that Ms. Rice provided respondent [IRS] with notice not to visit her at work or that her employer prohibits such visits. Accordingly, the revenue agent’s decision to deliver the Form 3552 to Ms. Rice at her place of employment was consistent with both section 6304(a) and section 6303(a), which states that a notice and demand for payment may be delivered to the taxpayer’s usual place of business.” 2012 T. C. Memo. 301, at p. 11.

So let IRS know they can’t come knockin’, or be prepared for them to come to you.

Well, Hurricane Sandy, Anyway

 No decisions out of Tax Court today, 10/26/12, or any interesting orders, and the Baltimore MD calendar session scheduled for Monday, 10/29, at 10 a.m., has been postponed to Wednesday, 10/31, at 2:30 p.m., in deference to the much-ballyhooed “Frankenstorm”. Tax Court’s man in Baltimore, Special Trial Judge Daniel A. (“Yuda”) Guy, has been busy clearing the calendar.

Oh, and the title of this post is a quotation from Macbeth, Act 5, Scene 5.

Stay dry and safe, everyone.

Tax Court just can’t get enough of those Section 170(h) cases, the delivery system for unguided Congressional largesse to the scenic and the historic. Yesterday it was Whitehouse Hotel Limited Partners (see my blogpost “Chipping Away the Facade – Part Deux”, 10/24/12). Now it’s Charles R. Irby and Irene Irby, et al., 139 T. C. 14, filed 10/25/12.

The Irby clan were members of an LLC that made bargain sales of wide-open Colorado spaces to Colorado Open Lands (COL), a 501(c)(3) that qualifies under Section 170(h)(3); bargain sales are below-market sales, in this case to charities. The portion of the purchase price paid by the charity results in gain to the seller, the below-market portion is a contribution (see Reg. Sec. 1.170A-4(c)(2)(ii)).

IRS claims the grant wasn’t protected in perpetuity, because government agencies that funded COL’s purchase are entitled to recapture out of the award if the land is condemned and the easement extinguished, so that all proceeds won’t go to COL in such event. But see my blogpost “’A Joy Forever?’ – Maybe Not”, 7/20/12. IRS also claims that the appraisal wasn’t qualified because it didn’t state it was made for income tax purposes. Finally, IRS claims there wasn’t a contemporaneous written acknowledgment of the gift from COL.

IRS loses all the way.

Judge Jacobs cites Kaufman v. Shulman, 687 F.3d 21, 26 (1st Cir. 2012): “paragraph (g)(6) appears designed in case of extinguishment both (1) to prevent taxpayers from reaping a windfall if the property is destroyed or condemned and they get the proceeds from insurance or condemnation and (2) to assure that the donee organization can use its proportionate share of the proceeds to advance the cause of historic preservation elsewhere.”

COL gets its share of proceeds after the government funders (all Section 170(c)(1) entities and all dedicated to preservation) get repaid. Thus no windfall to the Irbys, or diversion of funds from conservation purposes.

As to the appraisal: “Section 1.170A-13(c)(3)(ii), Income Tax Regs., provides that a qualified appraisal must include 11 categories of information to be a valid qualified appraisal. Respondent [IRS] challenges only one such category; respondent asserts that the appraisal petitioners rely upon does not meet the requirement of section 1.170A-13(c)(3)(ii)(G), Income Tax Regs., that the appraisal contain ‘A statement that the appraisal was prepared for income tax purposes’. Respondent argues that the appraisal and addenda to appraisal Mr. Butler drafted do not include such a statement and consequently they are unreliable because there is no assurance that Mr. Butler applied the proper standards of care to ensure that the reports conformed to Internal Revenue Service (IRS) standards.” 139 T. C. 14, at pp. 25-26. (Footnote omitted).

Judge Jacobs tosses out this far-fetched argument: “…the appraisal report in this case included all of the required information either in the appraisal or in the appraisal summaries attached to petitioners’ respective returns–it included a discussion of the purpose of the transaction (i.e., that the purpose of the appraisal was to value the donation of a conservation easement pursuant to the terms of section 170(h))…; it stated that fair market valuation was to be used in determining the value of the property; and Form 8283 was properly filed with petitioners’ respective returns. The IRS has not provided to the public a specific form for the tax purpose statement, and respondent has not proffered any instance where a suboptimal tax purpose statement, by itself, invalidated an otherwise qualified appraisal.” 139 T. C. 14, at p. 27 (Footnote omitted).

Finally, as to the contemporaneous acknowledgment by the donee, the Irbys introduce correspondence with COL and the funders, signed agreements and deeds, and the settlement statement for the transfers. IRS says that no single document satisfies Section 170(f)(8) acknowledgment. Judge Jacobs: “However, respondent does not assert, and we have found no authority to indicate, that the contemporaneous written acknowledgment may not be made up of a series of documents. We thus find that, collectively, the documents petitioners provided constitute a contemporaneous written acknowledgment.” 139 T. C. 14, at p. 31.

Takeaway–Do it right, and you get the deduction.

While the Cobblestoners avoided penalties when their facade easement got blown up (see my blogpost “Chipping Away the Facade”, 5/2/2012), the Whitehousers weren’t so lucky when Fifth Circuit sent them back to Tax Court. The case is Whitehouse Hotel Limited Partnership, QHR Holdings–New Orleans, Ltd., Tax Matters Partner, 139 T.C. 13, filed 10/23/12.

The Whitehousers claimed a $7 million facade easement on the Maison Blanche in the Big Easy. They were beaten in Tax Court first time around (131 T. C. 112 (2008)), but Fifth Circuit vacated that decision and sent them back to determine the value of the easement and whether the Section 6662(h) gross overstatement of value 40% penalty should apply. And again the Whitehousers collapse, both as to the value and the double whammy on the penalty.

The Whitehousers’ expert witness does them no good. He tries the replacement cost method of valuation but that doesn’t work for historic structures, because it is usually uneconomic to try to reproduce them. The income method doesn’t work here, because the building is a shell when the donation takes place, and there are just too many variables for the expert’s income projections to be accurate. And on comparables, Whitehousers’ expert wants to use comparables from other locales, claiming a national market for historic structures waiting to be turned into luxury hotels, but IRS’ expert finds enough local comparables to establish IRS’ figures. Remember, in real estate it’s location, location and location.

And the Whitehousers’ initial appraisal (prepared by someone else, but acknowledged by IRS to be an appraisal by a qualified expert) is too good to be true; their property did not appreciate 970% in three years.

And thereby hangs this tale.

Although there was an appraisal prepared by a qualified expert, the taxpayer must do more than rely upon it to avoid the Section 6662(h) gross overstatement of value. “In the case of a substantial or gross valuation misstatement with respect to charitable deduction property, however, the reasonable-cause-and-good-faith exception does not apply unless the taxpayer can show that (1) ‘the claimed value of the property was based on a qualified appraisal made by a qualified appraiser’, sec. 6664(c)(2)(A); and (2) ‘in addition to obtaining such appraisal, the taxpayer made a good-faith investigation of the value of the contributed property’, sec. 6664(c)(2) (B). The pertinent regulations, section 1.6664-4(g)(1), Income Tax Regs. (1977), make clear that the qualified-appraisal and good-faith-investigation requirements imposed by section 6664(c)(2) ‘apply in addition to the generally applicable rules concerning reasonable cause and good faith’.” 139 T.C.13, at p. 76. (Footnotes omitted).

Well, the appraisal they got was a qualified appraisal made by a qualified appraiser, even though IRS disagrees with the appraiser’s conclusion. See my blogpost “Method to His Madness”, 6/18/12.

But that’s not enough. The taxpayer must make a reasonable good-faith investigation to determine the value of the easement, even though the IRS concedes the Whitehousers got a qualified appraisal from a qualified appraiser.

The Whitehousers did nothing but attach the appraisal to their Form 8283. They didn’t ask how their appraiser determined that what they’d paid $9 million for could appraise for $96 million, or how the donated facade easement could reduce the worth of what they paid for by $7.45 million. They didn’t produce any evidence about what they discussed with their accountants and attorneys in preparing the Form 1065 with the huge deduction.

Thus the 40% penalty.

Takeaway– If it seems too good to be true, it usually is.

Ya gotta like Judge Gustafson, the obliging judge. As the old Jerry Lieber-Mike Stoller 1957 Coasters hit said “No matter where she’s hiding, she’s gonna see me coming, I’m gonna walk right down that street like Bulldog Drummon’. Gonna find her….”

Except it’s a “he”, not a “she”, but Judge Gustafson is searchin’ for Thomas John Babcock, Docket No. 21863-11, Order filed 10/19/12.

Tom was supposed to do some things, but he didn’t, and Judge Gustafson is concerned that Tom didn’t get the message, so Judge Gustafson orders his Chambers Administrator to hunt Tom down. “Petitioner Thomas John Babcock failed to comply with the Court’s order of September 24, 2012, failed to respond to the IRS’s motion to dismiss for failure to prosecute, and failed to appear for trial on October 15, 2012, at the Court’s Boston trial session. The Court is concerned that mail is somehow not reaching Mr. Babcock. An email address for him appears in the Court’s records, so the undersigned judge directed his Chambers Administrator to send the email attached hereto.” Order, p. 1.

Now that’s an obliging judge.

Such is Judge Marvel’s rebuke to John Allen Hatling and Kathleen Ann Hatling, 2012 T. C. Memo. 293, filed 10/22/12. John’s the bad actor here, and Kathleen is along for the ride.

John has been a lawyer in Minnesota for 25 years; he took at least one CLE course in IRS representation, and does estate planning. He got a 45-day license suspension when he pled guilty to felony non-filing of his State income tax return in 2008. For the three years at issue here, he filed returns stating no tax due, attaching Forms 8275 and 8275-R stating he was claiming a “claim of right deduction for white citizens”, although he stipulated he knew the claimed deduction was baseless and he was only stalling paying taxes.

Now this sounds like a run-of-the-mill protester case, which, as Guide Michelin used to say, “need not long detain the tourist”; or anyone else. But John did file the Forms 8275 and 8275-R and said exactly what he was doing; if you disclose what you’re doing, are you defrauding anyone?

While John stipulated that he filed the returns with the intent to delay assessment and payment of tax, Judge Marvel doesn’t rely on that alone. John did overstate his deductions; while his recordkeeping barely passes muster, his guilty plea on State tax counts against him, and he did file a false return. And he’s a lawyer (presumably) and should know better (ditto).

And the “I told you so” defense based on the Forms 8275 and 8275-R deconstructs. As usual, the answer is in the footnotes.

“Petitioners also appear to contend the claim of right deductions were not fraudulent because the deductions clearly were impermissible and therefore Mr. Hatling could not have been attempting to conceal his income. We reject petitioners’ contention for several reasons. First, the Code provides that taxpayers may deduct from income an amount received under a claim of right. See sec. 1341. Petitioners have failed to convince us that simply by including the claim of right deductions on their returns, they disclosed that the deductions they were claiming were clearly improper. Second, while the U.S. Court of Appeals for the Eighth Circuit, to which an appeal in this case would lie absent a stipulation to the contrary, see sec. 7482(b)(1)(A), (2), has not addressed the issue of whether a taxpayer’s disclosure may preclude a finding of fraudulent intent, at least two other Courts of Appeals, as well as this Court, have held that disclosure does not preclude a finding of fraudulent intent, see Edelson v. Commissioner, 829 F.2d 828, 832-833 (9th Cir. 1987), aff’g T.C. Memo. 1986-223; Granado v. Commissioner, 792 F.2d 91, 93-94 (7th Cir. 1986), aff’g T.C. Memo. 1985-237; Price v. Commissioner, T.C. Memo. 1996-204; Cloutier v. Commissioner, T.C. Memo. 1994-558. But see Zell v. Commissioner, 763 F.2d 1139, 1144 (10th Cir. 1985) (“Clearly, where the taxpayer has informed the IRS of his refusal to file or to pay, and of the reasons for that refusal, the government has not been deceived. In addition, the disclosure clearly negates any intent to deceive.”), aff’g T.C. Memo. 1984-152; Raley v. Commissioner, 676 F.2d 980, 983-984 (3d Cir. 1982) (holding that a taxpayer did not act with fraudulent intent because he “went out of his way to inform every person involved in the collection process that he was not going to pay any federal income taxes”), rev’g T.C. Memo. 1980-571. Third, petitioners deducted the claim of right deductions with the intent of underreporting their taxable income and evading their obligation to pay their proper income tax liabilities when due.” 2012 T. C. Memo. 293, at p. 14, footnote 13.

So John gets nailed for the 75% fraud penalty.

Not for nuthin’, as they say, but isn’t this a case where John went a bridge too far? He admitted he took a phony deduction to stall the IRS and failed to file his State income tax return. Let’s see if John takes an appeal, so we can see what Eighth Circuit has to say.

 Don’t Always Make Bad Law

Contrary to the old law school dictum dinned into my youthful ears on The Hill Far Above, hard cases sometimes don’t make bad law. Such is the story of William George West, Deceased, Docket No. 20428-11, filed 10/18/12.

There has been a real paucity of interesting decisions out of Tax Court the last few days, just unsubstantiated deductions and one egregious nonfiler-protester. Nothing here for the “man o’ independent mind”, who “looks an’ laughs at a’ that”, in the words of Scotland’s greatest.

So it’s off to the orders. And the late Bill and his widow (who, the Court notes, is not fluent in English) are the recipients of a heartwarmer from The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being, His Honor Mark V. Holmes.

Starts off quite routinely, SFRs for non-filed returns for two tax years, followed with SNODs. Petition filed, but the signer was unauthorized.

Now for the hard facts: “Mr. West, however, had not prepared the returns because he was seriously ill and he died just about the time the Commissioner was sending him the notices of deficiency. His widow — who is not fluent in English — filed the petition, but had no legal authority to do so. On September 19, 2012, the Commissioner moved to dismiss the case for lack of jurisdiction.

“The Court would be concerned at merely dismissing a challenge to deficiencies if that would lead to an assessment without a practically meaningful opportunity to challenge them. It therefore spoke with the parties on October 17, 2012. The Commissioner’s lawyer explained that Mrs. West had been able to find a preparer who worked with her and IRS Appeals to submit the missing returns and that the much lower tax bill those returns showed had already been assessed. Dismissing this case, therefore, is just cleaning up the paperwork.” Order, p. 1.

Clean up the paperwork and do justice at the same time. That’s my kind of Judge, even if he doesn’t appreciate the partitive genitive.

And the Grounds for Treating His Compensation as Compensation

Judge Holmes (The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being), again exhibiting his disdain for the partitive genitive (c’mon Judge, a “couple thousand people?”, 2012 T. C. Memo. 290, at p. 2), tells the tale of Harold Schmeets, a prominent citizen of Harvey, North Dakota. H & M, Inc., is the case, 2012 T. C. Memo. 290, filed 10/15/12.

Harvey is a tiny town where fewer people move in than die or move out. But Harold moved in forty years ago and stayed. He was a go-getter, known far and wide across prairie and badlands to the outermost little house on the prairie as The King of Insurance, even to his competitors, none of whom, it is admitted, can hold a ten-year  level-premium term life policy to Harold. He started selling insurance for the local bank, but bought out their insurance operation (a C corporation, of course) over the years. He was the acknowledged expert on bonding: getting payment, performance and completion bonds for contractors; and sweet-talking the big insurers into writing policies in this minuscule crossroads hamlet.

Finally, the bank buys out Harold, who wants to secure his old age and the educations of the kiddies he and Miz Mona bestowed on Harvey, ND,  to counterbalance the movers and diers.

Harold does the deal without an attorney and asks the bank’s accountant to look it over. Basically, the price for the name and goodwill of the agency is peanuts, and everything in an employment agreement with Harold.

IRS claims the deal is really a disguised capital gain at corporate rates and dividends to Harold. No, says Judge Holmes: “The bank’s insurance agency dropped its name in favor of Harvey Insurance Agency, Inc. because Harvey Insurance had been around longer and had more name recognition because of its association with Schmeets. Schmeets served as its manager for the entire six-year term of the employment agreement, and the bank reported his compensation as wages subject to withholding and Federal Insurance Contributions Act (FICA) tax. Schmeets rewrote existing insurance policies, took new applications, supervised and trained the agency’s four employees, attended bank planning sessions, negotiated commissions with insurance companies, and did the agency’s bookkeeping. The transition multiplied his responsibilities, and Schmeets went from a 40-hour work week before the sale to almost double that after.

“At the end of the six-year term, the bank was pleased with Schmeets’s performance and asked him to continue to manage the agency under year-to-year contracts. Schmeets agreed and kept working several days a week for about $30,000 per year to help train his replacement. The replacement was an insurance salesman that didn’t have as much experience as Schmeets–he didn’t do bonding work, and he had never been a manager. Despite this lack of experience, the bank paid the new man an annual salary of between $55,000 and $65,000. Having managed this last transition, Schmeets then retired.” 2012 T. C. Memo. 290, at pp. 9-10.

IRS claims form-over-substance: the bank bought the agency. Harold says no: the bank bought Harold.

Judge Holmes: “There will be no salable goodwill, however, where the business of a corporation depends on the personal relationships of a key individual, see Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 207-08 (1998), unless he transfers his goodwill to the corporation by entering into a covenant not to compete or other agreement so that his relationships become property of the corporation, see Norwalk v. Commissioner, T.C. Memo. 1998-279, 1998 WL 430084, at *7.” 2012 T. C. Memo. 290, at pp. 19-20.

Moreover: “The insurance business in Harvey is ‘extremely personal,’ and the development of Harvey Insurance’s business before the sale was due to Schmeets’s ability to form relationships with customers and keep big insurance companies interested in a small insurance market. He grew relationships with large insurance companies that other brokers in the area didn’t. And we specifically find that when customers came to his agency, they came to buy from him–it was his name and his reputation that brought them there. We also find he had no agreement with H & M at the time of its sale that prevented him from taking his relationships, reputation, and skill elsewhere, which was precisely what he did when he began working for the bank’s renamed insurance agency.

“Beyond the business’s goodwill, the Commissioner doesn’t specify what other purchased intangible assets, other than the name Harvey Insurance, he thinks were not accounted for in the purchase price. We have already found that the name Harold Schmeets had by far more name recognition in the community than Harvey Insurance. And the Commissioner hasn’t given us any persuasive evidence that the name of the corporation had much value other than its connection with Harold Schmeets himself.” 2012 T. C. Memo. 290, at pp. 21-22 (Footnote and citations omitted).

Harold’s personal taxes are not before the Court, so the question of adequacy of Harold’s compensation really isn’t an issue, although Harold’s replacement, a mere Baron or Earl of Insurance, says Judge Holmes, is paid twice what Harold was paid.

Harold runs into some of what they call “bob wahr” when it comes to a note from his wholly-owned corporation, and some unsubstantiated deductions, but they’re small compared to his employment as King of Insurance in the fair town of Harvey.

Takeaway- Goodwill counts for little if your name is your fame.

But Not If You Want the Gulf Opportunity Zone Deduction

That’s Judge Vasquez’s lesson to Brien C. Blakeney and Pamela A. Hall, 2012 T. C. Memo. 289, filed 10/15/12. It’s the saga of the bad ship Shockwave, a 62-foot Viking Convertible Yacht.  Brien bought her for his charter fishing company that operated out of Orange Beach, AL, smack-dab in middle of the Gulf Opportunity Zone, because it was smack-dab in the middle of Hurricane Katrina of infamous memory.

Shockwave was exactly that. Brien and his trusty master Captain Enos took delivery of this masterpiece of marine artistry in Florida, outside the Gulf Zone, to take it on a shakedown cruise prior to moving it to Orange Beach. However, it took nearly a year to get from Florida to Port Orange. The electrics fried routinely; seawater infiltrated the fuel tanks; something or someone stove a hole in her side as she lay at anchor under repair; the refrigeration equipment went on the fritz, frying the computer. Finally poor Captain Enos died, and Captain Stine, a hardy mariner, at last conned this latter-day Flying Dutchman into Port Orange.

Notwithstanding the foregoing, as the high-priced lawyers say, and even though ol’ Shockwave could barely make five knots with a following sea or go more than a mile or two offshore without imperiling passengers and crew before finally being repaired, the fish-filled waters of the Caribbean adjoining Florida permitted Brien to charter her for 43 days in those out-of-Zone waters (and get some personal use out of her along those lines), before ol’ Shockwave limped wearily into Port Orange, where she remained available for charter for some 74 days, but the fishing season had closed and nobody wanted to charter her.

Brien claims the 50% of purchase price bonus depreciation under Section 1400(N), Congress’ largesse to the battered businessfolk of the Gulf Coast. If you buy, place in service, and use business property in a trade or business substantially all of which is conducted in the Zone, the bonus is yours.

Brien claims that the use outside the Zone wasn’t use in business at all, as poor ol’ Shockwave couldn’t be used until finally fixed.

IRS claims “that under Notice 2006-77, 2006-2 C.B. 590, ‘substantially all’ of the Shockwave’s use was not in the GO Zone. Notice 2006-77, supra, provides that for the purposes of section 1400N(d)(2)(A)(ii) “substantially all” means 80% or more. Id. sec. 3.01, 2006-2 C.B. at 590.” 2012 T. C. Memo. 289, at p. 15.

No, says Judge Vasquez, IRS Notices do not have the force of law nor are they entitled to Chevron deference. See my blogpost “Carpenter, Colony, Chevron and Mayo”, 4/26/11. While Notices might be deferred to under Skidmore v. Swift & Co, 323 U. S. 134 (1944), we don’t need to go there. 43 days of charter in the Caribbean is 37% of the total of 117 days (74 in the Zone and 43 days out of Zone). That is substantial non-Zone use.

So Brien’s deduction sinks.