One sure way to drive a coach bananas is to fail to finish a play. Here Judge Vasquez admonishes IRS (gently) for not finishing. There might be some excuse, as this is one of the phony tiered partnership plus disregardeds, a son-of-Boss basis-builder, and it gets complicated. But Judge Vasquez unpacks it all in Rawls Trading, L.P., Rawls Management Corporation, Tax Matters Partner, Et Al., 138 T.C. 12, filed 3/26/12.

Facts are the usual. Jerry Rawls starts a business in his garage; in ten years it’s worth billions. Approached by a flim-flammer with lawyer and accountant in tow, Jerry and flim-flammer concoct a multi-layered series of partnerships with a trust thrown in, and a sale to an entity controlled by the flim-flammer. They build basis by using a short sale, where proceeds are reckoned into outside basis, but concurrent obligation to close short sale is not.

IRS issues three FPAAs to all hands, which are consolidated, but as consolidated two of the FPAAs only require computational changes to the interim partnerships, and the source partnership proceedings weren’t yet concluded.

IRS, realizing they were premature in issuing the deficiencies, asked for a stay, not a dismissal, claiming to dismiss will frustrate any chance to collect under the “no-second-deficiency” rule of Section 6223(f).

After the standard invocation, “our jurisdiction is strictly limited and only Congress can give us more”, Judge Vasquez answers the “no-second-deficiency” argument.

“We are cognizant of respondent’s concern that the ‘no-second-FPAA’ rule of section 6223(f) may be deployed as a shield to seek immunity for … from another round of partnership-level proceedings. In particular, respondent worries that if we hold invalid the … FPAA, then ‘the ability to issue a second notice under 6230(a)(2)(C) is not available.’ Motion to stay 10. Section 6230(a)(2)(C) carves out exceptions from the “no-second-deficiency notice” rule of section 6212(c), but only for affected items notices of deficiency issued under 6230(a)(2)(B). Section 6230(a)(2)(C) says nothing about the Commissioner’s ability to issue another FPAA to a partnership if the first FPAA has been held invalid.” 138 T. C. 12, at pp. 28-29. [Names omitted.]

So IRS can issue a new deficiency after it has finished with source partners, indirect partners, and Mr. Rawls his own self as a person whose tax liability is affected by taking into account, directly or indirectly, partnership items. See Section 6231(a)(2).

In the meantime, no stay, case dismissed, without a single dissenting word.

Give-Ups Don’t Count

That’s Judge Chiechi’s bad news for Vinny Nardone and Pilar Puerto, two hardworking Esq.’s who got Marc and Miriam off a huge tax hook in Marc A. Trzeciak and Miriam Trzeciak, 2012 T.C. Mem. 83, filed 3/22/12 (and if you wondered why I didn’t post this yesterday, I was at a meeting with the IRS; don’t ask.).

Miriam was a real estate pro (an actual real-live one), who owned and ran 14 single-family houses in the Greater Columbus, Ohio, metro area, that she rented out. Miriam lived in Dayton, and traveled from house to house, showing houses to prospective tenants, dealing with their complaints, engaging contractors, and doing all the admin and paperwork.

It’s a mighty long road from Dayton to Columbus, and Miriam spent a lot of time going to and fro on the earth and walking up and down on it. That travel time counts toward my pro-qualifying 750 hours and lets me take all the depreciation, said Miriam. Not on your pickup truck, said IRS; that’s home to work commuting and you’re numerous days late and a lot of dollars short. You got the $3K gimme, and owe tax by the bushel-basket.

Miriam’s accountant claimed that the travel was part of the activity because of the time and distance. He claimed that travel is inherent in real estate activities and can’t be commuting. IRS tells him, politely, to take a walk in the country.

He never said the magic words “home office”. That would have let Miriam claim she went from one job site (home office) to the others (the 14 houses); ergo, no commuting from home. So the revenue agent who audited Miriam put it this way: “The taxpayer [Ms. Trzeciak] does not employ anyone to handle the management of the properties, and handles bookkeeping, advertising ** *, paying bills, collecting and depositing rent, scheduling major maintenance, and performing minor maintenance, and tenant relations, mostly performed from her [petitioners’] residence. No mention was made of a space [in petitioners’ residence] that was used regularly and exclusively for the taxpayer’s rental activities.” 2012 T. C. Mem. 83, at p. 4.

Maybe if she hauled goods for her operations that might count, but Miriam never said she did. After much palaver, little of it to the point, Miriam gets hammered, plus a substantial understatement penalty (the revenue agent ignoring “reasonable cause”, like reliance upon said accountant, which Judge Chiechi does not like. See 2012 T.C. Mem. 83, at p. 12.).

Comes now Vinny and Pilar. At first they, too, blew past the “home office” argument, leaving it out of the petition. IRS denies everything in its answer. Vinny and Pilar counter with a Section 7430(c)(4)(E) qualified offer, to which IRS doesn’t respond.

After the pretrial order is served on both sides, Pilar e-mails IRS’ counsel, stating the magic language. IRS’ counsel demanded proofs, Pilar sent them along, and before pretrial memoranda were due, the parties had a settlement giving Miriam everything she asked for.

When Vinny and Pilar moved for entry of judgment based on the settlement, they attached an affidavit from the accountant claiming he told IRS about the home office from the get-go. Miriam had filed documents that varied from the accountant’s tale. The Court didn’t hold a hearing because the parties never asked for one.

Now Vinny and Pilar want Section 7430  money. Once again the magic words are “substantially justified”.

Judge Chiechi: “A significant factor in determining whether the Commissioner’s position is substantially justified as of a given date is whether, on or before that date, the taxpayer has presented all relevant information under the taxpayer’s control and relevant legal arguments supporting the taxpayer’s position.

“The Commissioner’s concession of an issue is not conclusive as to whether the Commissioner’s position with respect to that issue was substantially justified.” 2012 T. C. Mem. 83, at p. 30.

The magic date for substantial justification is the petition date, at which point neither Miriam nor anyone else had suggested that Miriam had a home office. Vinny and Pilar argued that IRS should have asked.

Judge Chichi says “no”, or more precisely: “With respect to petitioners’ contention that, because petitioners presented information to respondent during the administrative proceedings that Ms. Trzeciak did work relating to her rental properties in petitioners’ residence, respondent had an obligation during those proceedings, which respondent failed to satisfy, to ask petitioners to provide respondent with documentation or other substantiation establishing that Ms. Trzeciak maintained a work area or an office in petitioners’ residence that qualified as Ms. Trzeciak’s section 280A principal place of business and thus her tax home office, we disagree. We do not believe that respondent’s knowledge during the administrative proceedings that Ms. Trzeciak did work relating to her rental properties in petitioners’ residence imposed an obligation on respondent to ask petitioners to provide respondent with documentation or other substantiation establishing that Ms. Trzeciak maintained a work area or an office in that residence that qualified under section 280A as her principal place of business and thus her tax home office. It was petitioners’ obligation, and not respondent’s obligation, to provide documentation or other substantiation establishing that Ms. Trzeciak maintained a work area or an office in that residence that qualified under section 280A as her principal place of business and thus her tax home office to respondent.” 2012 T. C. Mem. 83, at pp. 35-36.

Although the revenue agent mentioned at the audit stage working at home in a space regularly and exclusively, the accountant never followed up. In short, petitioners, “don’t ask, don’t tell” is not the rule.

“We find that, in the light of the facts available to respondent at the time the answer was filed and existing legal precedent, respondent’s position in this case had a reasonable basis in both fact and law.” 2012 T. C. Mem. 83, at p. 39.

But what about the qualified offer? Vinny and Pilar are out of luck again, as Section 7430(c)(4)(E)(ii)(I) does not permit counsel fees where the matter is settled, not tried to judgment.

I hate it when the lawyers don’t get paid.

Sorry, guys, March Madness is upon us, so I place a basketball metaphor on an estate tax case, once again featuring inclusion-exclusion. This time it’s an insurance policy, taken out by Decedent Dave for the benefit of his loved-once, Sweet Sue, and their minor offspring. The case is Estate of David A. Kahanic, Deceased, Edward M. Fiala, Executor, 2012 T.C. Mem. 81, filed 3/21/12, Judge Vasquez holding court.

Decedent Dave ran an outfit called Aesthetic Eye Plastic Surgery, that apparently did well enough for Decedent Dave to buy a $2.495 million life insurance policy from Reliastar Insurance (wasn’t it great when insurance companies had real names, like “Security”, or “Home”? Now they sound like rock groups).

Of course, when Sweet Sue bailed on Decedent Dave and entered into a marriage settlement agreement, she made sure Decedent Dave had to keep the policy current.

Decedent Dave shuffles off this mortal coil, the 706 (filed by Ed Fiala, executor and brother of Sweet Sue), includes the policy as an asset of the estate, but claims an offsetting deduction based on Sweet Sue’s security interest therein. IRS allows a $500K deduction, because the original settlement agreement gave her a $500K security interest.

But Sweet Sue had to drag Decedent Dave through the courts to get him to live up to their agreement. Finally, with contempt hanging over his head, Decedent Dave agreed not to change the policy or the beneficiary designation, encumber it or transfer it, and that was embodied in a “so ordered” stipulation. He did stop paying premiums, but the no-lapse clause and his previous premium payments kept the policy alive, even when Decedent Dave wasn’t. So Sweet Sue gets the whole $2.495.

But Decedent Dave’s estate has a lot less in it than first thought. There was a lot less cash available, and there was less to Aesthetic Eye than first met the eye. Moreover, there was no contribution clause in Decedent Dave’s will, so Sweet Sue was looking at transferee liability.

IRS wanted to limit Sweet Sue to the $500K of the original agreement, but Sweet Sue claimed the result of the contempt proceeding worked a modification of said agreement, and gave her enough of the incidents of ownership of the $2.495 policy to take it out of Decedent Dave’s estate.

No, says Judge Vasquez, Section 2042 says if Decedent Dave had any incidents of ownership, the whole policy (less IRS’ conceded $500K) is in. The magic language in Section 2042 is subsection (2): “To the extent of the amount receivable by all other beneficiaries as insurance under policies on the life of the decedent with respect to which the decedent possessed at his death any of the incidents of ownership, exercisable either alone or in conjunction with any other person. For purposes of the preceding sentence, the term ‘incident of ownership’ includes a reversionary interest (whether arising by the express terms of the policy or other instrument or by operation of law) only if the value of such reversionary interest exceeded 5 percent of the value of the policy immediately before the death of the decedent. As used in this paragraph, the term ‘reversionary interest’ includes a possibility that the policy, or the proceeds of the policy, may return to the decedent or his estate, or may be subject to a power of disposition by him.”

The estate offers no evidence on the worth of Decedent Dave’s reversionary interest, and concedes that if the policy had any value at Decedent Dave’s date of death it was greater than 5%. I am at a loss to understand why Ed Fiala gave away the ranch in that wise, but he did.

IRS claims that since the policy was paid up beyond Decedent Dave’s death, the reversionary interest was the unapplied premium, and, per Ed’s concession, was more than 5% so the policy stays in. Ed says, “no cash surrender value”. Judge Vasquez: “…decedent’s final premium payment provided him with coverage until September 1, 2005. Thus, as of the date of decedent’s death, the Reliastar policy could have provided 20 days’ more coverage. …the Reliastar policy’s fair market value as of August 11, 2005, would at least be the cost of insuring decedent for 20 days, or $390.79.” 2012 T.C. Mem. 81, at p. 33 [Footnote omitted.].  Moreover, cash surrender value is not the only criterion for measuring a policy’s FMV.

Now, given Ed’s concession, $390.79 lets IRS claim the 5% reversionary interest and subject the whole policy to estate tax (less the conceded $500K).

But the ball bounces out. Ed argues Section 2516 provides full and fair consideration for Sweet Sue’s security interest in the policy, via the contempt proceeding modification of the original settlement agreement. And property encumbered in exchange for fair and reasonable compensation is not included in the taxable estate to the extent of the indebtedness per Section 2053(a)(4).

So the policy is in the estate, then out of the estate, and Sweet Sue comes down with a $2.495 million rebound.

Sweet Sue lent the estate money to pay the taxes, and there’s plenty in the decision about that, so read it.

But Hold Onto that Withholding Argument

 The only non-protester Tax Court decision today is Donald Carl Barker, 2012 T.C. Mem. 77, filed 3/20/12.  While it starts out interestingly, it turns out to be just another “how to fail in business because you weren’t really trying”, Section 162-meets-Section 183.

Don was a high-powered NASA space ranger, manager of one of the Mars Lander programs. Don had more degrees than Lord Kelvin’s thermometer, and Judge Goeke lists them all.

After nearly 20 years of working on hi-tech gizmos, Don tried to patent a cheap communications system he devised in his spare time, using off-the-shelf, user-friendly components. This was some years before the year at issue, but the Patent Office blasted his device into outer space, claiming someone got there before him. Just a poor working dude, Don says he didn’t have the cash to pursue the patent.

You can guess the rest. Don applied for NASA grants sporadically, ran up travel and entertainment expenses (for which Don claimed Hurricane Ike washed away his records), and never made a cent. But he did take business deductions.

Judge Goeke runs this through the Section 183 spectroscope, and sends Don’s deductions into the void. Not businesslike, too sporadic, no records, deductions for activities in years other than year at issue–the usual.

But yesterday’s orders had an interesting one, Michelle D. Brown, Docket No. 7540-09, Order dated 3/19/12. The point is that a withholding tax credit is not the subject of a deficiency, and therefore Tax Court can’t hear it, but maybe they can, later.

Judge Paris: “During 2003 petitioner was a resident of Texas, a community property state, and filed her 2003 Federal income tax return as married, filing separately without splitting her tax items with her husband. However, if a husband and wife domiciled in a community property State make separate returns, each spouse for Federal income tax purposes, must report half of the community income, such as wages, and half of the credit allowable for taxes withheld on such income. See sec. 66; secs. 1.31-1(a) and 1.66-1(a), Income Tax Regs.’ The Internal Revenue Service audited petitioner’s 2003 return and adjusted petitioner’s tax items accordingly. As a result petitioner did not owe Federal income tax in 2003, but she claimed an excessive withholding credit that created a refund overpayment of $5,067.” Order, p. 1.

Michelle had gotten a SNOD for several previous years, settled those with IRS, but left 2003 open. The SNOD included the 2003 overcredit. But now IRS argues that the overcredit IRS seeks to recoup is not a deficiency permitting Michelle to pass within the Section 6213 strait-and-narrow gate to Tax Court.

Judge Paris again: “Under section 6211(b)(1) a deficiency is determined ‘without regard to the credit under section 31’. Section 31 generally allows the taxpayer to claim a credit for Federal income tax withheld from wages for that taxable year. The amount of an overstated credit may be summarily assessed and is not subject to deficiency procedures. Sec. 6201(a)(3); Breein v. Commissioner, 74 T.C. 1097, 1104-1105 (1980). Since the withholding credit issue is not a factor in determining a tax deficiency, the Court does not have jurisdiction to consider whether petitioner is entitled to the withholding credit that created an excessive refund in 2003. Cf. Whalen v. Commissioner, T.C. Memo. 2009-37 (when determining an overpayment for a related deficiency proceeding or penalties the Court may consider withholding credits).” Order, p. 2.

But Michelle’s fight about the withholding credit is not lost.

Judge Paris gives Michelle the good news: “Although the Court does not have jurisdiction to address petitioner’s 2003 tax year at this time, petitioner has yet to receive an opportunity to dispute the underlying tax liability for that year. In the event of a collection hearing, petitioner may challenge the existence or amount of the underlying tax liability for 2003. See sec. 6330(c)(2)(B); Montgomery v. Commissioner, 122 T.C. 1 (2004).”

Don’t give up, Michelle.

The Lawyers Did Not Get Paid

Section 7430 gives taxpayers who prevail against IRS a shot at reasonable legal fees and costs, provided the IRS’ position in the litigation wasn’t “substantially justified.” Whatever that phrase may mean isn’t always clear, but Maritza Furiatti Newman finds that it’s clear enough to Judge Gustafson for him to deny Maritza’s application for same in Maritza Furiatti Newman, 2012 T.C. Mem 74, filed 3/19/12.

Maritza and her pal Oscarlina worked for the Brazilian Government’s aircraft entity in the Brazilian Embassy in Washington, concededly a diplomatic mission and both doing the same sort of work as Americans working for the US in our embassy in Brazil, and Brazil didn’t tax the American’s wages. However, for the years at issue, the US  Secretary of State didn’t get around to giving Maritza and Oscarlina the Section 893(b) blessing. So IRS, having launched an initiative to tax the unblessed furriners, hit Maritza and Oscarlina with deficiencies, nonfiling and nonpaying penalties.

Maritza and Oscarlina first hired counsel on a fee basis, but counsel switched to pro bono (non-fee) when the costs got too high. Finally, Maritza and Oscarlina bade their counsel adieu, and after appeals failed, filed their own Tax Court petitions.

But then IRS loses Abdel-Fattah v. Commissioner, 134 T.C. 190 (2010), where Section 893(a) is held separate from 893(b), which means the State Department blessing isn’t necessary if the facts comport with Section 893(a); Abdel goes off on “plain meaning,” although the Abdel Court doesn’t say IRS’ position is crazy.

So eventually IRS bails on Maritza and Oscarlina.

Lo and behold,  “…[Maritza] re-engaged as counsel the same lawyers who had assisted her in her administrative proceedings but had not filed her petition in this litigation. …three days after the issuance of the Abdel-Fattah Opinion, petitioners’ counsel filed their entry of appearance in [Maritza]. … the IRS informed petitioners’ counsel that it intended to concede in [Maritza].

“Less than a month later…[Oscarlina] reengaged as counsel those same lawyers. Counsel filed their entry of appearance in [Oscarlina] three days later….

“The record does not show the reason for petitioners’ counsel’s exit from and re-entry into these pro bono cases.” 2012 T.C. Mem. 74, at p. 9. Perchance these hard-laboring pro bono counsel saw a chance actually to get paid? Ya think?

Comes the Section 7430 application. Yes, you prevailed, says Judge Gustafson, but the IRS wasn’t crazy, and you have to do more than win. “The relevant inquiry is whether the IRS knew or should have known that its position was invalid when adopted, given the facts available and any legal precedent related to the case. The Supreme Court has warned that courts must ‘resist the understandable temptation to engage in post hoc reasoning by concluding that, because a plaintiff did not ultimately prevail, his action must have been unreasonable or without foundation.’ Or, as the Court of Appeals for the D.C. Circuit put it, ‘courts need to guard against being ‘subtly influenced by the familiar shortcomings of hindsight judgment.’

“The IRS’s position may be incorrect but nevertheless substantially justified ‘if a reasonable person could think it correct’. The IRS’s eventually conceding or even losing a case does not establish that its position was unreasonable, but its concession does remain a factor to be considered.” 2012 T.C.Mem. 74, at pp. 15-16 [Citations omitted.]

IRS had an argument in Abdel that Tax Court didn’t just blow off. Then,  when they lost, IRS had to decide whether to appeal Abdel, and whether to issue an Action On Decision if they didn’t (and ultimately IRS did issue an AOD). Then they had to decide the specific Section 893(a) factual issues with Maritza and Oscarlina. IRS was entitled to time to deal with the serious questions here, and Abdel was a case of first impression.  Substantial justification all the way.

Sorry, counsel, no money for you.

I wish Judge Halpern had been more explicit about good faith reliance in Salvador F. Neri and Guadalupe Neri, 2012 T.C. Mem. 71, filed 3/15/12.

The case was yet another Section 104 “no hurt, no exclusion” cases. I’ve blogged two others already, “No Hurt, No Foul?”, 11/1/11, and “Don’t Do It, Litigator”, 12/5/11, and Neri has nary to add to the basic principle enunciated time and again.

But what interests me about Neri is what Judge Halpern didn’t say. Sal excludes the $210K arbitration award he got on account of family and medical leave breaches by Sal’s employer, but neither his complaint nor the arbitration award talks about any physical injury, except tangentially mentioning a prior condition already cured. So game over, under Section 104.

Now comes the Section 6662 20% accuracy penalty. The only thing Judge Halpern mentions is that Guadalupe testifies on the trial that the Neri’s attorney told her and Sal the award was nontaxable. That attorney neither tried this case nor was called as a witness (and if he had tried this case, would he have been permitted to testify, even though no jury is involved?). Nothing stated in the decision touches upon that attorney’s tax qualifications, although he apparently shredded the defendant’s witness on the arbitration hearing.

Judge Halpern quotes the Regulations, Section 1.6664-4(b)(1), and says that the facts and circumstances let the Neris off the hook for accuracy. But Judge Halpern gives us no particularization of which of the facts and circumstances tip the scales Neri-ward. In the wilderness of single instances, which is the basis of our law, any thread from which we can suspend a reasoned evaluation in aid of our clients, and the public generally, is to be welcomed. And Tax Court judges, who encounter the good faith reliance argument every day, are those best fitted to guide us. I wish we had been given more guidance this time.

That’s the problem with exercising unqualified stock options on restricted stock, as is made clear to Patrick J. Sheedy and Karen J. Sheedy, 2012 T.C. Mem. 69, filed 3/14/12 (happy pi day).

Pat was a mortgage lender and a senior official in a subprime loan packager. When the corporation for which he worked restructured, Pat got what looked like a juicy stock option. There were the usual hooks: the stock was restricted by SEC regulations, could not be sold for a year, and could only be sold to accredited investors. The option deal was shown in the S-11 filed with SEC, but Pat never introduced that at trial. Pat also signed an accredited investor letter: he stated he was sophisticated, understood the risks, knew he couldn’t easily sell, and had all the necessary information he needed to make a reasoned investment decision.

Pat exercised the option, and got a W-2 showing that he did. Pat tried to unload the stock. The corporation never went public, so the only market was run by FBR Capital Markets, Inc. FBR, formerly Friedman, Billings, Ramsey & Co., Inc., is an investment adviser offering investment banking, sales, and trading services. At the material dates FBR was a registered broker-dealer that was a member of the NASD and NASDAQ. Moreover, it was the leading bookrunner (bid and ask broker) for restricted stock like what Pat was trying to unload.

Pat tried to unload via FBR, but no dice. Finally, overwhelmed by the subprime market meltdown, the corporation cratered, went into liquidation and sank without trace. Pat lost everything but the Section 83(a) deficiency based on the difference between FMV of the stock at exercise (as shown by FBR’s trading reports) and the exercise price (minuscule). Pat claimed a theft loss based on the deterioration of the corporation.

Pat claims IRS has to prove the validity of the W-2, based on Section 6201(d). But Pat and IRS stipulated the W-2 and the FBR sales figures, so IRS did introduce proof. Pat introduces none to prove the FBR sales numbers were wrong.

Now where property received in exchange for services has no market value, it need not be recognized under Section 83. But property has no value only in rare and exceptional circumstances. In short, there’s almost always a buyer for anything–at the right price.

The stock may have been restricted when it came to sale to the public at large, but Pat had ownership, control, benefits and burdens; there was no substantial risk of forfeiture.

Pat owned the stock outright, and there was a market, albeit restricted, for the stock.

But here, as in many other cases, Tax Court has to decide a case in the absence of careful lawyering (and both parties had counsel here). Judge Laro: “We begin our discussion of the fair market value of … stock by noting an evidentiary void caused by each party’s failure to call an expert witness on the matter. Expert witness testimony, while certainly not determinative of value, may prove helpful in assisting the Court to understand areas requiring specialized knowledge, experience, training, or judgment. See Fed. R. Evid. 702. Petitioners bear the burden of proving the fair market value of … stock, see Morris v. Commissioner, 70 T.C. 959, 988 (1978), and that burden is steepened in the absence of reliable and reasonable expert opinion on the point in question.” 2012 T. C. Mem. 69, at pp. 18-19.

Judge Laro goes on: “Whereas isolated stock sales may not be a reliable measure of fair market value in the face of contrary evidence, see Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 278 (1979), petitioners have not introduced evidence casting doubt on the sales which FBR facilitated other than petitioner’s self-serving trial testimony. We scrutinize carefully unsubstantiated testimony of interested parties. See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). In this case, we decline to credit petitioner’s testimony absent corroborating evidence. Petitioners have offered no expert opinion evidence on the matter. They did not introduce a copy of the Form S-11 registration statement filed with the SEC in June 2006 establishing the primary offering price, though petitioner testified that his decision to exercise the options was based in part on the fact that the form was filed.” 2012 T.C. Mem. 69, at pp. 20-21.

Deficiency sustained. However, IRS generously gives Pat and Karen a $750,000 short-term capital loss on their worthless stock, based on  the value thereof as determined by Tax Court. Pat and Karen can take that at the rate of $3,000 per year. Those guys are all heart.

At Least for Section 131

That’s Judge Colvin’s pick-up from a case tried by The Great Dissenter, Judge Holmes, Jonathan E. Stromme and Marylou Stromme, 138 T.C. 9, filed 3/13/12.

Marylou’s disabled brother Danny was the impetus for her and Jonathan to use their Emil Avenue house (originally bought for investment) as a residence for developmentally disabled adults. Jonathan acted as general contractor to remodel and upgrade the Emil Avenue house to county standards, and four disabled persons lived there. Marylou and Jonathan started a business, got licensed and paid by the county for caring for their inmates, hired additional staff (some family, some not) to help, and excluded the payments under Section 131.

But Marylou and Jonathan also owned other houses, one on Mound Avenue that they later sold and one on LaCasse Drive. “It was at the LaCasse Drive house that the Strommes held family get-togethers and celebrated the safe return of another son from service in Iraq. The LaCasse Drive house was also where they celebrated Thanksgiving and Christmas. Ms. Stromme found it a more restful place to recover from foot surgery. This was in part because the LaCasse Drive house was much larger than the one on Emil Avenue. Excluding the basement, the LaCasse Drive house had 2,808 square feet, in contrast to the 1,168 square feet of the Emil Avenue house–and it was large enough to accommodate the Strommes’ extended family and everyday life. Its six bedrooms often housed not only the Strommes and their two children, but also two other children from Ms. Stromme’s first marriage, plus Ms. Stromme’s brother, a niece, and two grandchildren. It also was large enough for the Strommes to bring their clients over for outings.” 138 T.C. 9, at pp. 5-6.

Marylou and Jonathan claimed they owed no tax on the county payments (about $500K), because they cared for the disabled persons in their home. But was Emil Avenue their “home”?

Section 131 excludes from income “…payments if they were:

• made pursuant to a foster care program of a State;
• paid by a State or political subdivision thereof, or a qualified agency; and
• paid to a foster care provider for the care of ‘a qualified foster individual in the foster care provider’s home.’

“See sec. 131(b)(1). The parties disagree about the third requirement. Does the phrase ‘foster care provider’s home’ merely require ownership, as petitioners contend; or does it mean the foster care must be provided in a taxpayer’s residence, as respondent contends? We conclude that it means the foster care must be provided in a taxpayer’s residence.” 138 T.C. 9, at pp. 8-9.

Briefly, home is where you live. Ownership is not enough. And Marylou and Jonathan couldn’t prove that they lived, as distinct from worked, at Emil Avenue.

Judge Colvin: “The only case on the meaning of ‘home’ in section 131 is Dobra v. Commissioner, 111 T.C. 339 (1998). In Dobra, the taxpayers owned four houses where they cared for developmentally disabled people, but conceded that only one house was their ‘personal family residence.’ Id. at 340. The Dobras nevertheless argued that because they owned each house, they could exclude payments tied to the individuals in all four. Id. at 342. We held, however, that under section 131 a person’s ‘home’ is where he resides. ‘Put more plainly, in order for a ‘house’ to constitute * * * [a home], petitioners must live in that house.’ Id. at 345. Precedent fences us in: The Strommes’ mere ownership of the Emil Avenue house is insufficient to make it their home.” 138 T. C.  9, at p. 10.

So no exclusion.

There is much judicial fencing about whether “home” means “principal residence” for Section 131 exclusion, which would disqualify even a secondary residence, and whether Tax Court needs to decide that now. Judge Holmes has a concurrence that deals with those points, although Judge Gustafson doesn’t agree with him.

But Marylou and Jonathan escape the negligence penalty. The law is ambiguous, they did report receipts even though they claimed they weren’t taxable, and even the IRS publications dealing with the issue don’t try to define what is a “home” for Section 131 purposes.

Judge Holmes Deconstructs an Apartment Building

And How to be a Tax Fraud

Two for the price of one today.

Judge Holmes, the Judge who writes like a human being, has written another advanced tax accounting text in Amerisouth XXXII, Ltd., Amerisouth Texas III, LLC, Tax Matters Partner, 2012 T.C. Mem. 67, filed 3/12/12. Judge Holmes has ridden this range before (see my blogpost “Basis for Dummies,” 11/24/11), and this time he sprinkles his prose with cowboyisms (the property at issue is in Mesquite, Texas, although the parties shuffle off to Buffalo, New York, to try the case), and a few groaner puns.

Amerisouth XXXII (hereinafter “32”) is one of a string of apartment house tax shelter deals run by old-time Texas real estate operator Ruel Hamilton, who disappears after trial, so no post-trial brief is filed, and 32’s attorney are relieved (in more ways than one).

Ruel decides to use the component approach to depreciation (see my blogpost “Buying Trouble”, 1/18/12), trying to take MACRIS class lives for every single piece of 366 apartments in more than 40 buildings on 16 acres of Texas.

Ruel tries to get out of the 27.5 year residential realty life by deconstructing the entire building, via an analysis by MS Consultants, to accelerate depreciation deductions. He’s literally throwing in the kitchen sink (or sinks: there are hundreds of them).

I remember seeing this gambit played before the Tax Reform Act of 1986, and even after that by a few hardy souls. Like auto racing, it can be fun, but dangerous.

I won’t quote, much less try to paraphrase, Judge Holmes’ 61 pages of analysis, beginning with a property description that beats any broker’s set-up I ever saw, and marches resolutely through the maze of regulations, statutes both current and repealed, and a maze of decided cases. But any tax professional, who has to deal with what is a structural component and what is personal property, and the various class lives of the latter, should read and heed.

Another gem this date is Michael A. Scott, 2012 T.C. Mem. 65, filed 3/12/12. Mike is a dentist who claims he made no money for the years at issue. When IRS challenges this assertion, Mike fires off letters to banks, threatens to sue bank employees, tries to quash IRS subpoenas, and is less than credible on the witness stand, according to Judge Halpern.

I’ll digest the 50 pages of this decision thus: if you want a blueprint for how to be adjudged a tax fraud and subject to the Section 6663(a) 75% solution, just follow Mike’s example. Better yet, don’t.

No decisions out of Tax Court on 3/9/12, so a couple of orders caught my wide unwinking eye.

First is William Craig Soucy, Docket No. 596-12. It’s a short tale, told by Judge Colvin, thus: “On March 6, 2012, respondent filed a Motion To Dismiss for Lack of Jurisdiction on the ground the notice of deficiency was issued after the expiration of the period for assessment and collection provided under I.R.C. section 6501(a). Respondent states in the motion to dismiss that petitioner does not object to the granting of the motion.

“It is well settled that an allegation concerning the expiration of the period of assessment and collection is an affirmative defense and not a plea to the jurisdiction of this Court. Badger Materials, Inc. v. Commissioner, 40 T.C. 1061 (1963); see also Robinson v. Commissioner, 57 T.C. 735 (1972).” Order, at p. 1.

No reason why petitioner should object, the SOL has run and IRS is literally Sans Soucy (sorry, guys). But SOL, as Judge Colvin points out, is an affirmative defense. It has to be pled and proven. So he tells IRS and Sans to file a status report, or better still, submit decision documents.

Next is Albert Bront and Victoria Y. Pavlenko, Docket No. 16198-10S. Al was an IRS Grade 14 Revenue Agent gone to the Dark Side. DOJ claimed he filed false tax returns, helped others to do so, and capped off his career by threatening to assault and murder a Federal law enforcement agent officer in violation of 18 U.S.C. section 115(a)(1)(B). Al pled guilty to a count of Section 7206(1) violation, and two counts of Section 7206(2) violations, all of which were either filing false returns himself, or assisting others in that nefarious practice.

Judge Wherry takes up the story at page 3 of the Order: “…Mr. Bront appeared with his criminal counsel in front of the Honorable Otis D. Wright and entered his plea of guilty to counts 4, 10, and 13 of the first Superceding Indictment [The Section 7206 violations.]. After an extended discussion with Mr. Bront, the court found that the plea was a knowing and voluntary plea supported by an independent basis in fact containing each of the essential elements of the offense and accepted Mr. Bront’s guilty plea.

“… the United States District Court for the Central District of California entered a judgment of guilty as to counts 4, 10, and 13 of the First Superceding  Indictment. Mr. Bront has appealed the judgment insofar as it relates to his sentencing and the computation of tax loss. Mr. Bront has taken no action in the United States District Court or on appeal to withdraw his guilty plea.” Order, at  p.3.

Now Al wants to dispute certain adjustments to his tax return for one year at issue, and incidentally the Section 6663 civil fraud penalty IRS wants to tag him with.

IRS says “collateral estoppel. You pled guilty to fraud, so you can’t try to undo the effects.”

Judge Wherry gives the short course on issue preclusion, a/k/a collateral estoppel: “Statements made by a taxpayer in a prior case, whether written or oral, are judicial admissions and bind the taxpayer in future actions.

“Collateral estoppel precludes a party to a prior suit from relitigating in a later suit issues of fact and law that were actually and necessarily decided by the prior court in reaching judgment in the prior suit. It exists for ‘the dual purpose of protecting litigants from the burden of relitigating an identical issue and of promoting judicial economy by preventing unnecessary or redundant litigation.’ There is no difference between a judgment of conviction based on a guilty plea and one rendered after a trial on the merits.

“For Federal tax litigation, collateral estoppel applies when (1) the issues of law and fact in the second suit are the same as the issues in the first suit; (2) a court of competent jurisdiction has rendered a final judgment; (3) the parties in the second suit are the same or in privity with the parties in the first suit; (4) the issues were actually litigated in the first suit; and (5) the controlling facts and legal principles are unchanged.” Order, at pp. 3-4. (Citations omitted.)

Al claims he’s going to bring a habeas corpus proceeding, and therefore his conviction isn’t final, but he hasn’t done so, and even if he did, the conviction is still a conviction until overturned. Even then, his admissions are admissible in a civil proceeding.

OK, Al is estopped, right? Not quite, says Judge Wherry: “The problem is that Mr. Bront never agreed to the specific factual allegations contained in the First Superceding Indictment regarding his 2006 tax year and the ones respondent argues he should be estopped from contesting. We agree with respondent that ‘a guilty plea is an admission of all the elements of a formal criminal charge.’ But establishing specific tax liabilities is not an element of section 7206(1) and consequently none need to be determined.” Order, at pp. 5-6 (Citations and footnote omitted).

So even though Al hasn’t formally petitioned, he asked in a status report to prove his return was in fact correct, and Judge Wherry will give him a shot.

Even better, Al isn’t estopped to challenge the Section 6663 fraud penalty. He did say in his Plea Agreement: “’[he] is liable for the fraud penalty imposed by the Internal Revenue Code, 26 U.S.C. § 6663, on the understatement of tax liability for tax years 2003, 2004, 2005, 2006, and 2007.’ But Mr. Bront was never found guilty of this by the District Court for the Central District of California nor was this issue fully litigated, and therefore Mr. Bront is not estopped from contesting his liability for the civil fraud penalty of section 6663.” Order, at p. 7 (footnote omitted, but read it, it’s more useful stuff about collateral estoppel).

And though Al’s statements might be construed as judicial admissions, those relate to facts, not law. A defendant’s admissions are not conclusive on a question of law.

Good learning here, even if it doesn’t make the Decisions page.