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.

But IRS’ plea, echoing the Marvelettes’ 1961 hit (covered by the immortal Beatles), falls on Judge Wells’ deaf ears, and Scott White’s petition is dismissed in the eponymous not-for-nuthin’ Section 7463, 2012 T.C. Sum. Op. 53, filed 6/11/12.

Scotty’s fighting about a $500 deficiency. He claims he never got the SNOD IRS claims they sent, but instead Scotty got a letter from IRS, which he attached to his petition, that gave the wrong date for filing the petition, more than 90 days after the mailing of the SNOD. IRS claims Scott is too late, and moves to dismiss for want of jurisdiction.

But IRS fails the proof test. Judge Wells: “A U.S. Postal Service (Postal Service) Form 3877 offered by respondent at trial and with his motion stated that the notice of deficiency was mailed on August 30, 2010, to petitioner at his last known address, which was also the address he used throughout his correspondence with the IRS and this Court. However, at trial, because the Form 3877 respondent offered was not signed by a Postal Service employee and because it did not state the number of items the Postal Service received, respondent moved to withdraw his motion to dismiss for lack of jurisdiction.” 2012 T.C. Sum. Op. 52, at p. 3. (Footnote omitted.)

But after trial, IRS tries to reopen the record to put in a print-out from USPS’s online track-and-confirm showing mailing and attempted delivery, and claims “business record in ordinary course” to get around hearsay. For non-lawyers, hearsay means that the person who said or did whatever must be proved is not in Court, and someone else is saying what the absent person said or did, although they themselves weren’t there. That’s generally a no-no, as the trier of fact (judge or jury) and the opposing party need to look the witness in the eye and cross-examine.

But there is an exception in this case. A business record kept in the regular course of business (even by a non-profit), made roughly contemporaneously with the activity in question by someone whose job it is to make the record, certified by a representative of the recording entity (even if not the person who made the record), can be admitted as evidence. For more about this penguin than you want to know (unless you’re studying for the Tax Court Admissions Exam in November), see Fed. R. Evid. Section 902.

Guess what? There’s yet another exception (don’t you just love this stuff?). Judge Wells lays it out: “However, rule 902(11) of the Federal Rules of Evidence contains a notice requirement: A party intending to offer a record into evidence ‘[b]efore the trial or hearing * * * must give an adverse party reasonable written notice of the intent to offer the record–and must make the record and certification available for inspection–so that the party has a fair opportunity to challenge them.’” 2012 T.C. Sum. Op. 52, at p 6.

See my blogposts “Don’t Ambush the Indians,” 4/7/11, and “Don’t Ambush the Accountants, Either,” 8/17/11. And here Scotty is the ambushee, because the trial is over and he never got to see this record IRS wants to use to sandbag him, in advance of trial.

Even if IRS had tried to introduce the printouts at trial, Scotty got no pre-trial warning. Now Fed. R. Evid. Section 902 doesn’t prescribe a specific number of days, hours or even minutes for giving notice before trial, but the Courts have said it has to give the opposing party a fair chance to check out the record and those who made it.

So no go, IRS. The Postal Service 3877 is no good because doesn’t state the number of articles presented and not signed by the USPS clerk, the printouts are no good because Scotty never saw them pre-trial, so case dismissed for want of jurisdiction, but not because Scotty is late.

Why Taxpayers Need Representation in Tax Court

The few people who read this, my blog, may remember my blogpost “A Book and a Modest Proposal”, 5/22/12. I said that Tax Court is a minefield, that even experienced practitioners have taken nasty falls there, and that the current “closed shop” of a virtually unpassable admission examination restricts effective representation to all but those able to afford expensive and experienced counsel.

The taxpayer with a small claim (small to others but not to the taxpayer) is left to advance his or her claim unaided, while IRS has battalions of attorneys who do nothing but Tax Court practice.

Case in point, as usual a Section 7463 small claim, little noted nor long remembered, William L. Weaver and Dorothy J. Weaver, 2012 T. C. Sum. Op. 52, filed 6/7/12. This was a Rule 122 stipulated facts case, so there was no hearing and no oral testimony.

The tax is not at issue, so I’ll summarize quickly. Dottie was a US person employed by the Consulate of the True North Strong and Free to drum up business for the Canadians. Dottie got sick, and finally resigned due to sickness. Canada generously gave her a final payment based upon seniority and tenure under the Maple Leaf flag.

Dottie had her joint return with Willie the Weaver (Civil War buffs will remember the original words to “Dixie” featured Willie the Weaver, who was a gay deceiver, but no deceit here) done by an unnamed tax pro, who reported the Canadian Farewell as “other income”, and didn’t file a Form 1040SE or tell Dottie and Willie to pay self-employment tax thereon.

No question Dottie was an employee, and employees don’t usually pay self-employment tax, but (a) Dottie worked for a foreign government (see Section 3121 and my blogpost “Not An Employee For Tax Purposes?”, 5/24/11), and (b) the Canadian payment was based on tenure and seniority, and was not payment for bodily injury (see Section 104 and my blogposts “No Hurt, No Foul”, 11/1/11, and “Don’t Do It, Litigator”, 12/5/11).

So it’s severance pay, not disability pay, and therefore it’s ordinary income, not damages for bodily injury. So only self-employment tax is due, because Dottie paid income tax on the payment already.

So far, no big thing.

Now for the Section 6662(a) substantial underpayment penalty. No question there was substantial underpayment due to the SE, but Dottie claims she used a tax pro to prepare the return. Of course, the stipulated facts say nothing about what Dottie told the pro.

That’s enough to sink Dottie. Judge Kroupa: “Petitioners have not established that their reliance on their return preparer was reasonable and in good faith. This case was fully stipulated. That does not relieve petitioners, however, of their burden. Petitioners failed to demonstrate that they provided all the necessary and accurate information to the return preparer. We cannot turn a blind eye to this oversight and simply accept petitioners’ assertion alone that they relied upon the return preparer as a defense against the accuracy related penalty. See Peacock v. Commissioner, T.C. Memo. 2002-122. Moreover, petitioners failed to otherwise show that their failure to report the payment as selfemployment income was due to reasonable cause and was in good faith.” 2012 T. C. Sum. Op.at p. 10. Penalty sustained.

Now if there had been a trial, and Dottie had had a chance to call as a witness the tax pro she used, put him or her on the stand and have the tax pro tell Judge Kroupa what Dottie told him, or get on the stand herself and tell Judge Kroupa what she told the tax pro, she maybe would have had a chance to knock out the penalty ($1782.00).

But how could Dottie know that was what she had to do? And if she was disabled so she couldn’t work, presumably so that she couldn’t personally appear at a hearing, what choice had she but to stipulate? And how could she afford a representative, be that representative an attorney or a Tax Court Practitioner who had passed through the eye of a needle that is Tax Court admission for other than attorneys, who could tell her what to stipulate, and prepare an appropriate affidavit either from Dottie or from the tax pro for a Rule 122, much less brief and try a case, for a $1782 penalty?

Now this is not a political blog; I’m bored with saying I grind no axes here. And I don’t fault Judge Kroupa; she is bound by the record she has, not by the record Dottie maybe should have presented.

But this just isn’t right.

Or, If You Do It Right, You Can Do It Among Yourselves

That’s the takeaway from James Maguire and Joy Maguire, 2012 T.C. Memo. 160, filed 6/6/12.  Judge Ruwe is in the driver’s seat in this tale of two S Corps, one that sells used cars and the other that provides financing for those sales. Both the S Corps are owned by the Famiglia Maguire, hence these tears, as IRS claims the Famiglia’s mix-and-match with accounts receivable from one S Corp to the other to build basis for loss deductions didn’t really happen.

Oh no, says Judge Ruwe, the swap was real. “Held: Shareholders in two related S corporations are not prohibited from receiving a distribution of assets from one of their S corporations and then contributing those assets into another of their S corporations in order to increase their bases in the latter. The effect is to decrease the shareholders’ bases in the S corporation making the distribution and thereby reducing the shareholders’ ability to get future tax-free distributions from the distributing S corporation, while increasing the shareholders’ bases in the S corporation to which the contributions are made. The fact that the two S corporations have a synergistic business relationship and are owned by the same shareholders does not preclude accomplishing Ps’ goal, so long as the underlying distributions and contributions actually occurred.” 2012 T. C. Memo. 160, at p. 2.

Ya gotta like a Judge who makes it easy for the poor blogger.

The story:  Auto Acceptance (AA) sold cars, CNAC, Inc., financed the sales. CNAC made money, AA lost money. The Famiglia owned 100% of the stock of both, but their basis in AA was insufficient for them to take all the AA losses, as S Corp pass-through losses are limited to stock basis plus debt basis.

The Famiglia called their accountants, who told them to write a check from CNAC, where they had plenty of basis, to themselves and from themselves to AA, to increase their AA basis so they could take the losses. The Famiglia replied that the accountants could write their own checks, as the Famiglia didn’t have that much cash in the CNAC accounts.

Nothing daunted, the accountants (into whose professional credentials Judge Ruwe goes in some detail, for good-faith reliance purposes) suggest distributing to the Famiglia some receivables AA owed CNAC, whereupon the Famiglia would  transfer those to AA, and build basis thereby.

The Famiglia’s basis in CNAC was always positive after the distribution of the AA receivables to themselves and the contribution thereof to AA.

The Famiglia and the accountants papered the deals well, with corporate resolutions, adjusting journal entries, assignments, promissory notes for intraFamiglia borrowings, and took the AA losses.

IRS drops the SNODs, saying it was all a game of put-and-take.

Judge Ruwe: “In determining whether a particular transaction qualifies as a shareholder investment, a taxpayer must make an actual ‘economic outlay.’ A taxpayer makes an ‘economic outlay’ when he incurs a cost or is left poorer in a material sense after the transaction.” 2012 T. C. Memo. 160, at pp. 11-12 (Citations omitted).

IRS says there wasn’t any real economic outlay, but Judge Ruwe isn’t buying that. The Famiglia did transfer the receivables, in that there were adjusting journal entries on the respective corporate books, and there were resolutions, for each tax year at issue, timely made.

“When petitioners received the accounts receivable from CNAC, as they had every right to do, and contributed them to Auto Acceptance, that transaction reduced the liabilities of Auto Acceptance; made Auto Acceptance solvent in terms of its assets exceeding its liabilities; and increased the net worth of Auto Acceptance, exposing a greater amount of its assets to its general creditors. At the same time, petitioners’ bases in CNAC were reduced by the amounts of the accounts receivable that CNAC had distributed to them, thereby reducing their ability to receive future tax-free distributions from CNAC.” 2012 T. C. Memo. 160, at pp. 14-15 (Footnote omitted).

But the footnote says a lot: “Petitioners stress that the risk involved in exposing more of Auto Acceptance’s assets to its creditors was more than hypothetical, because by mid-2004 the Kentucky attorney general had instituted a lawsuit against petitioners and their businesses claiming millions of dollars on the basis of consumer fraud claims. Petitioners contend that the risk of the loss to Auto Acceptance’s creditors, including vendors that it alone dealt with, when viewed in consideration of the attorney general’s lawsuit, was very real and the additional net worth in Auto Acceptance created by the capital contribution was put at greater risk, making them poorer in a material sense.” 2012 T. C. Memo. 160, at p. 15, footnote 7.

Likewise the distribution from CNAC wasn’t taxable to the Famiglia under Section 1368(b), as the Famiglia still had basis in their CNAC stock after each distribution.

The Law of Relativity doesn’t torpedo the Famiglia either: “The fact that the CNAC accounts receivable were distributed to petitioners and then contributed to a related entity does not require a finding that there was no economic outlay. We have previously considered this issue and have held that ‘the fact that funds lent to an S corporation originate with another entity owned or controlled by the shareholder of the S corporation does not preclude a finding that the loan to the S corporation constitutes an “actual economic outlay” by the shareholder.’ The fact that petitioners contributed intangible assets to Auto Acceptance, rather than cash, does not preclude increases in their bases. The tax basis of an S corporation may be increased through the contribution of cash, tangible assets, or intangible assets (such as accounts receivable).” 2012 T. C. Mem. 160, at p. 16.

Or to put it simply, “(T)he fact that the two S corporations have a synergistic business relationship and are owned by the same shareholders should make no difference so long as the underlying distributions and contributions actually occurred.” 2012 T. C. Memo. 160, at p. 16.

Make it real, and you’ve got the losses.

Or, If You’re Not Indicted You’re Not Stayed

In the words of Paul Simon’s 1970 blockbuster hit (No. 47 on Rolling Stone’s 500 greatest hits), “when you’re down and out, when you’re on the street, when evening falls so hard”, you’ll get no comfort from Tax Court unless you’ve at least been indicted. So rules hard-hearted Judge Goeke (he who gave The Great Dissenter, Judge Holmes, the Judge who writes like a human being, a firm time-out in Petaluma FX Partners, LLC, Ronald Scott Vanderbeek, A Partner Other Than The Tax Matters Partner, 2012 T. C. Mem. 142, filed 5/17/12; see my blogpost “Judge, He Didn’t Mean It”, 5/17/12), in Ironbridge Corp. and Subsidiaries f.k.a. Pitt-Des Moines, Inc., 2012 T.C. Mem. 158, filed 6/5/12.

Ironbridge was another casualty of the Forex mix-and-match shenanigans of the late Nineties, whereby recognized major currency (Euro and Yen) puts were married to unrecognizable minor currency (Danish Kroner) calls, with offshore tax indifferents thrown in, so the economics zeroed out but not the tax benefits. A big-time accounting firm put Ironbridge into one of these, and IRS, Zeus-like, flung SNODs like thunderbolts.

Meantime, DOJ got into the act, and Haber, president and panjandrum of Ironbridge, was concerned that he might be principal soloist in a concerto for stool pigeon and Grand Jury.

While the foregoing was foregoing, Ironbridge petitions Tax Court, but IRS and Ironbridge seriatim ask for stays, saying that to try the case would prejudice DOJ (in that Ironbridge could get discovery of the criminal matters beyond that permitted by Fed. R. Crim. P.) and that Ironbridge couldn’t meet their burden of proof if Haber and certain of his unnamed minions took the Fifth at the trial.

However, DOJ finally sends Haber a “dear defendant” letter, wherein they state that they’re investigating, but not to worry, we have no present intention of indicting either you or your companies. Think IRS told DOJ to send that letter? No prize for the correct answer.

Anyway, “On March 27, 2012, petitioners filed a motion to dismiss the consolidated cases and enter decisions against them. Petitioners stated that they filed the motion as a result of their inability to present the testimony of Mr. Haber and other individuals who planned to invoke their Fifth Amendment rights. Petitioners claim that the lack of such testimony ‘would prevent the petitioners from being able to put on their case at trial’ because ‘Testimony from * * * [these] witnesses is critical to petitioners’ ability to meet their burden of proof in these cases’. Respondent objected to petitioners’ motion to dismiss on the grounds that ‘The principles of judicial economy require a final determination of these issues in this proceeding, which only a decision on the merits or an agreed stipulated decision can produce.’ Respondent is concerned that petitioners’ motion ‘is merely an attempt to unnecessarily prolong and delay this proceeding.’” 2012 T.C. Mem. 158, at pp. 4-5.

Oh yes, and in the alternative Ironbridge asked for yet another stay.

This launches Judge Goeke into a disquisition anent the stay of civil proceedings in criminal cases, which I’ll leave, as is my wont, to the law review writers and the terminally insomniac. Here’s a brief preview: “The District Courts of the Second Circuit have often used the following six-factor balancing test: (1) the extent to which the issues in the criminal case overlap with those presented in the civil case; (2) the status of the case, including whether the defendant (here, petitioners) has been indicted; (3) the private interests of the plaintiff (here, respondent) in proceeding expeditiously weighed against the prejudice to plaintiff (respondent) caused by the delay; (4) the private interests of and burden on the defendant (here, petitioners); (5) the interests of the courts; and (6) the public interest. Id. at 99-100. After considering each factor, as explained herein, we found the cumulative weight of the factors to favor denying the stay.” 2012 T. C. Mem. 158, at p. 6.

The bottom line, however, is “…petitioners are not at risk of criminal prosecution (thereby reducing the possible future use of collateral estoppel to zero), and it does not appear likely that Mr. Haber is in criminal jeopardy. Given that it is uncertain whether Mr. Haber will even be indicted, granting the motion could result in the imposition of a lengthy and indeterminable stay for no reason.” 2012 T.C. Mem. 158, at p. 9.

No stay, guys, and Section 7459(d) gives IRS judgment for the amounts stated in the SNODs upon dismissal of the petition on any ground other than want of jurisdiction. “The acceptance or rejection of a proffered concession is a matter within the discretion of this Court, and we should exercise our discretion in accordance with the ‘interest of justice’. See Jones v. Commissioner, 79 T.C. 668, 673 (1982); McGowan v. Commissioner, 67 T.C. 599, 607 (1976). Respondent has not suggested how the interests of justice would compel us to deny petitioners’ motion, and we can conceive of no injustice in granting petitioners’ motion.” 2012 T.C. Mem. 158, at pp. 10-11 (Footnote omitted).

Oh, and here’s the omitted footnote: “Respondent has stated that petitioners’ motion is merely an attempt to delay the proceedings and that judicial economy requires either a decision on the merits or else execution of ‘a stipulated decision effectuating a final, full, and complete concession of this case by petitioners.’ However, respondent has not specified how granting petitioners’ motion would delay the proceedings. We note that ‘A decision rendered upon a default or in consequence of a dismissal, other than a dismissal for lack of jurisdiction, shall operate as an adjudication on the merits.’ Rule 123(d); see also Settles v. Commissioner, 138 T.C. ___, ___ (slip op. at 4) (May 8, 2012); Estate of Ming v. Commissioner, 62 T.C. 519, 522-523 (1974.).” 2012 T.C. Mem. 158, at p 11, footnote 4.

As to Settles, above cited, see my blogpost “Dismissed!”, 5/8/12. And as to IRS’ demand for “either a decision on the merits or else execution of ‘a stipulated decision effectuating a final, full, and complete concession of this case by petitioners’”, see my blogpost “Victory is not Vindication”, 5/1/12. If the taxpayer can’t get “full, final and complete concession”, neither can IRS. You won, so go away.

Readers of my blogpost “To Have and Have Not”, 8/31/11, will remember the sad tale of Clyde W. Turner, Sr., who had when he should have had not, and thereby torpedoed his estate plan. But a happier fate befalls the Estate of George H. Wimmer, Deceased, George W. Wimmer, Personal Representative, in 2012 T.C. Mem. 157, filed 6/4/12.

George I and wife Ilse set up a Family Limited Partnership, ostensibly to invest in land and stocks. George I and Ilse, general partners, never bought land, but they bought some good dividend-paying, publicly-traded stock. And the trust instrument provided “…partnership profits are allocated to the partners according to their proportional partnership interests. All distributions of net cash flow are also shared among the partners in proportion to their partnership interests. Distributions must be made in cash pro rata. The partnership agreement, as amended, provides that the primary source for distributions is distributable cash derived from partnership income.” 2012 T.C. Mem. 157, at p. 6 (Footnote omitted).

Now the trust George I and Ilse set up for the grandchildren was a limited partner, the grandbabies had the right to annual distributions from the trust corpus, and the trust did get its dividends along with everybody else.

As usual, the initial limited partners were George I and Ilse, and they gifted out partial limited partnership interests every year, staying under the $10,000 (now $13,000) per head radar. Also as usual, transfers of the limited partnership interests, otherwise than interfamily, were strongly restricted.

Judge Paris didn’t seem sure whether any extrafamily transfer required 70% or 100% approval by all limiteds. “The transfer of limited partnership interests requires, among other things, the prior written consent of the general partners and 70% in interest of the limited partners. Upon satisfaction of the transfer requirements, the transferee will not become a substitute limited partner unless the transferring limited partner has given the transferee that right and the transferee: (1) accepts and assumes all terms and provisions of the partnership agreement; (2) provides, in the case of an assignee who is a trustee, a complete copy of the applicable trust instrument authorizing the trustee to act as partner in a partnership; (3) executes such other documents as the general partners may reasonably require; and (4) is accepted as a substitute limited partner by unanimous written consent of the general partners and the limited partners.” 2012 T. C. Mem. 157, at p. 3. Then again, the limited partnership agreement isn’t crystal clear, either.

Howbeit, every limited partner was entitled to receive net cash distributions, and they did, every year, in proportion to their respective limited partnership interests.

George I shuffles off this mortal coil, and IRS claims the limited partnership interests George I and Ilse gifted to the family are not gifts of present interests, therefore not excludable from gross estate of George I.

Now a present interest is an unrestricted right to the possession, use and enjoyment of property or the income therefrom. “The terms ‘use, possess or enjoy’ connote the right to substantial present economic benefit, that is, meaningful economic, as opposed to paper, rights.” 2012 T. C. Mem. 157, at pp. 8-9 (Citations omitted).

But limited partnership interests may or may not be present interests. The interests the grandbabies and other limited partners got might not differ from what they would get if they were beneficiaries of a trust. Here, however, Judge Paris finds that, although the donees of the limited partnership interests did not get an unrestricted right to those interests, they sure got the right to the income.

Judge Paris: “…the estate must prove, on the basis of the surrounding circumstances, that: (1) the partnership would generate income, (2) some portion of that income would flow steadily to the donees, and (3) that portion of income could be readily ascertained.” 2012 T. C. Mem. 157, at p. 10 (Citation omitted).

Well, the limited partnership held dividend-producing, publicly-traded stock, so there should have been income (and there was), it would flow steadily (the generals were fiduciaries under State law and the limited partnership agreement said they had to distribute net cash), and the amount was readily ascertainable (just check the dividend history of the corporations whose stock was held).

Result: the grandbabies and the other limited partners had, and George I’s estate had not, so the gifts were properly excluded from George I’s estate.