Archive for September, 2013|Monthly archive page


In Uncategorized on 09/30/2013 at 17:57

That’s when Tax Court closes tomorrow, guys, so get those filings in. If you’re dealing with Court-imposed deadlines, you get 5 days from when the shutdown ends, but if that’s a Saturday, Sunday or legal holiday (in DC), you get until the next working day. But the petitioning deadlines stay the same, so use the Section 7502 mailed-is-filed rules.

Check out the website:

Click to access Shutdown_Public_Statement_September_30_2013.pdf



In Uncategorized on 09/30/2013 at 17:04

Maybe Sometimes You Should

 That’s Judge Kerrigan’s message to the daughters of  Jean Steinberg, Donor, in 141 T. C. 8, filed 9/30/13.

Jean made a deal with her four adult daughters, and does a lot better than King Lear did when he made a deal with his three.

Jean, aged 89, gifts her daughters a girnormous wad of cash and marketable securities, on two conditions, and it’s a double-whammy: the kids have to stump up any Federal gift tax Mama would be hit with, and, if Mama shuffles off this mortal coil during the three-year death-gift penumbra, the daughters get to pay the estate tax as well. Cf. poor old Doc Shel Sommers and his wife Bernice, stars of my blogpost “Artistically Gifted”, 1/11/13, when IRS tries to slug Bernice with the same story.

IRS claims Jean understated her gift tax by better than $1.8 million, because she deducted the value of the daughters’ undertakings to front the taxes.

But Jean’s lawyers drew up a tough agreement, with the daughters losing their right to further distributions if they didn’t pay up. And there was a lot of negotiation between Jean’s lawyers and the daughters’ lawyers.

Each had separate counsel. Reminds me of the New Yorker cartoon showing a bunch of people leaving the conference room, each accompanied by a gentleman in a suit with a bowtie, glasses and a briefcase, but one such is standing in a corner. Caption: “Has everybody got a lawyer? I seem to have an extra.”

Anyway, Jean and the daughters got an appraisal. The appraiser took the mortality tables to figure out how much more mileage Jean has before she goes to the great Garage in the Sky, and the numbers derived go into the Form 709.

“Petitioner attached a summary of the net gift agreement, which included a description of the appraiser’s determination of the value of the net gifts, to the Form 709.” 141 T. C. 8, at p. 6.

IRS disallows the estate tax guesstimate, and Jean petitions.

IRS moves for summary judgment (no facts disputed, so no trial necessary).

Judge Kerrigan: “…respondent [IRS] does not dispute (1) the value of the cash and securities transferred; (2) whether petitioner properly reduced her gift tax liability by the amount of gift tax the donees assumed; or (3) whether the donees’ assumption of the section 2035(b) estate tax liability is enforceable under local law. Respondent’s sole claim is that the donees’ assumption of the potential section 2035(b) estate tax liability did not increase the value of petitioner’s estate and therefore did not constitute consideration in money or money’s worth within the meaning of section 2512(b) in exchange for the gifts.” 141 T. C. 8, at p. 8.

Now gift tax paid on gifts made within three years of death get added back to the estate for estate tax, because formerly the tax paid was both a credit against estate tax and a reduction of the tax base, making deathbed gifts a good tax deal. No more; and even net gift tax (gift tax paid by donee) goes back into the estate.

IRS claims that the undertaking to pay estate tax if Jean buckets within three years is worthless. All Jean gets is peace of mind. Therefore her estate is not depleted, as it would be if she had to pay gift tax.

The question is whether Jean got anything determinable in money or money’s worth when the daughters agreed to pick up the taxes. Whether the daughters lost in the deal is irrelevant; the test is did Jean benefit.

Yes, as to the gift tax clearly, because the gift tax would have reduced Jean’s available cash.

Now, all the way back in McCord v. Com’r., 120 T.C. 358 (2003), rev’d and remanded sub nom. Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006) , Tax Court held “in advance of the death of a person, no recognized method exists for approximating the burden of the estate tax with a sufficient degree of certitude to be effective for Federal gift tax purposes.” 120 T. C. at p. 402, cited at 141 T.C. 8, at p. 17.

At best, said the McCord Tax Court, the mortality tables prove what premium an insurer would take to cover the risk. Moreover, “the dollar amount of a potential liability to pay the 2035 tax is by no means fixed; rather, such amount depends on factors that are subject to change, including estate tax rates and exemption amounts (not to mention the continued existence of the estate tax itself).” Citing McCord, 120 T. C. 402, at 141 T. C. 8, at p. 17.

Prescient of Tax Court to see, in 2006, the expiry of the estate tax in 2010.

Anyway, McCord was reversed and remanded by Fifth Circuit, but that doesn’t matter, as Jean is a New Yorker and Fifth Circuit doesn’t apply to New York. (Might be time for a Federal Tax Circuit, so we get one nationwide rule for a nationwide tax.)

And cases involving multiple contingencies don’t count, because here there’s only the chance of Jean checking out in the three years following the gift. And the fluctuation in tax rates is a given, but every willing buyer and willing seller (those imaginary chaps) reckons his price based upon today’s tax rates. And courts have recognized that the value of an appreciated gift must be reduced by capital gains taxes payable by the donee, even if the donee doesn’t immediately sell.

IRS argues that Jean’s death in the three-year gulch is too speculative to fix a value. No, says Judge Kerrigan, the cases say that just because something is not inevitable, it’s not too speculative.

And just because the estate tax benefit was to the estate of the donor (she being dead at the time the estate would come into being), and not to the donor herself, doesn’t get it. Tax Court thought so in McCord, but now agrees with Fifth Circuit. In this case, the donor and her estate are inextricably bound.

So the assumption by the daughters of the estate tax liability may have enough worth to give rise to reduction in gift tax.

IRS claims this is not a business deal, but it is an intrafamily deal, and therefore not made for consideration. Wrong, says Judge Kerrigan. The gift tax deal wasn’t a business deal and it was intrafamily, but that’s OK, so this should be too. Besides, they all had lawyers, they negotiated for months, and nothing suggests this was a “sweetheart” deal.

But we have a real issue of fact on the appraisal. Was the assumption of estate tax liability consideration in money or money’s worth? Go to trial, guys.


In Uncategorized on 09/30/2013 at 15:50

Or, Virginity Regained

 I was waiting for the last blast from Tax Court before the shut-down today (and that’s the only reference I’ll be making in that regard; Mr. Patrick Temple-West of Reuters asked me what I’d be doing if Tax Court shut down, and I replied I’ll be taking a break), when an old friend I happened to meet, as Redd Stewart and Pee Wee King put it in their 1947 hit song “Tennessee Waltz”.

I’d missed Third Circuit’s reVirginization of Richard and Lana Vento, the stars of my blogpost “The Non-Virgin Islanders”, 3/13/11, whose lack of Virgin Islands sociability got Judge Sanchez to blow up the tax benefits from their flight to our beautiful but insolvent Islands in the Sun.

Judge Kroupa brings us up to date in DTDV, LLC, Richard G. Vento, Tax Matters Partner, Docket No. 741-09, filed 9/30/13. And I apologize for missing Third Circuit’s at-least-partial rescue of la famille Vento.

Judge Kroupa: “…Third Circuit Court of Appeals issued its opinion concerning the residency status of Richard Vento and Lana Vento as well as their daughters Gail Vento, Renee Vento and Nicole Mollison. The Third Circuit determined that Richard Vento and Lana Vento were residents of the U.S. Virgin Islands for income tax purposes for the tax year 2001 and that Gail Vento, Renee Vento and Nicole Mollison were not residents of the U.S. Virgin Islands for income tax purposes for the tax year 2001. None of the parties filed a petition for writ of certiorari with the Supreme Court, so the decision of the Third Circuit is final.” Order, at p. 2.

I understand Third Circuit was less impressed by lack of library cards and driver licenses, and the art collection back on the mainland, than by all the money the Ventos spent trying to rehab their VI residence, and decided that was good enough. But check out Judge Hardiman’s exegesis yourself.

Not a whit dismayed, IRS charges on against the Vento children.

Judge Kroupa: “…respondent issued FPAAs in 2008 to three limited liability corporations controlled by Richard Vento, known as Nicole Vento, LLC, Gail Vento, LLC and Renee Vento, LLC (Vento daughter LLCs). The Vento daughter LLCs filed an appeal to the district court for the U.S. Virgin Islands contesting the FPAAs issued by respondent. The Vento daughter LLCs district court cases concern issues similar to those involved in these cases pending before the Tax Court. The district court held a trial, issued an opinion and entered judgments in the Vento daughter LLCs’ cases upholding the adjustments contained in respondent’s FPAAs and imposing a negligence penalty under I.R.C. § 6662. The Vento daughter LLCs filed appeals with the Third Circuit Court of Appeals contesting the district court’s judgments. Those appeals have not yet been resolved and are currently pending with the Third Circuit.” Order, at p. 2.

The Ventos want to go to trial in Tax Court now.

No, says Judge Kroupa: “The Court strives to move cases to resolution as quickly and efficiently as possible. The Court does not believe, however, that it would be in the best interests of the parties or the Court to schedule these consolidated cases for trial at this time especially given that the Third Circuit currently has the related cases under advisement.” Order, at p. 2.

So lets see what Third Circuit does and try these cases next year, maybe.


In Uncategorized on 09/27/2013 at 17:34

Ready to Pitch? Maybe Not

It’s rare that I see two contradictory orders, especially one day apart. See my blogpost “Come In From The Bullpen”, 9/26/13, wherein Judge Wherry greeted the relief attorney for Jere and Neva Jefcoat with a stern admonition to start pitching.

But today, The Judge With A Heart, STJ Armen, “(A)fter due consideration, and for cause more fully appearing in the transcripts of the proceedings” (which transcripts we don’t get to see), gives the relief attorney for pro se Donald R. McWeeney a bye and continues (that is, adjourns) Don’s trial.

Frank Agostino, Esq., is the reliever, and both he and Don stand before STJ Armen and ask for the bye. IRS objects, but STJ Armen both gives Don and Frank the bye, and denies IRS’ motion to sanction Don, apparently for not playing show-and-tell with documents (but denied without prejudice, so IRS can try again if Don and Frank don’t play nice).

Apparently Don and Frank’s respective tales of woe suitably impressed STJ Armen enough to let Frank take some warm-up pitches while he does a Branerton with IRS.

The whole story is found in Donald R. McWeeney, Docket No. 15453-12S, filed 9/27/13.


In Uncategorized on 09/26/2013 at 17:33

And she’ll get HOH, dependency, child and Earned Income credits, even without a Form 8332. That’s the good word for pro se Mom Jennifer D. White, 2013 T. C. Sum. Op. 77, filed 9/26/13, from The Judge With A Heart, STJ Armen.

Jen and ex Randy produced two children before they severed the tie. Their separation agreement provided for joint legal custody and for all sorts of visitation, but said nothing about who got the tax deductions or credits for the kids. More important to IRS, the agreement stated that Randy was the “custodial parent”.

When Jen claimed the parental panoply, IRS gave her a SNOD, stating that ex Randy got the tax breaks as custodial parent.

No, says Jen, the kids lived with me for more than half of each of the years at issue, and only the elder turned the magic age in the second year. And Jen provided more than half the support of one child in each such year, and the other for one year.

Right you are, Jen, says STJ Armen: “The provisions of section 152(e) identify circumstances where the noncustodial parent may claim a child. Pursuant to section 152(e)(4)(A) and (B), the term ‘custodial parent’ means the parent having custody for the greater portion of the calendar year, and the term ‘noncustodial parent’ means the parent who is not the custodial parent. Section 1.152-4(d), Income Tax Regs., defines custody as follows: ‘[t]he custodial parent is the parent with whom the child resides for the greater number of nights during the calendar year, and the noncustodial parent is the parent who is not the custodial parent.’”  2013 T. C. Sum. Op. 27, at pp. 7-8. (Footnote omitted).

No dispute that the kids lived with Jen more than half of each year, she provided more than one-half the support of one in each year, and that she provided one half the support of the other for one year. One was the right age for both years, and the other for one year.

Jen gets the whole enchilada, even without Form 8332.

Remember, the other “paid but got no tax breaks” cases I’ve blogged were those where the children didn’t live with the payor parent for more than half of any of the years at issue in those cases, and the payor parent never got Form 8332 for each year they claimed.


In Uncategorized on 09/26/2013 at 16:48

Ready to Pitch

That’s Judge Wherry’s (the Whimsical Judge) word to the attorney for Jere D. & Neva C. Jefcoat, Docket No. 7772-11, filed 9/26/13.

I’m taking my text from another Jeffcoat, the late Harold Bentley (“Hal”) Jeffcoat, who pitched for the Cubs, Redlegs and Cards many years ago.

Jere and Neva’s present attorneys move to withdraw, IRS waves bye-bye to them, and Jere’s and Neva’s new attorney is walking in from the bullpen.

Judge Wherry welcomes him with the news that he won’t get time to warm up. “…the parties are cautioned that the Court will not grant a continuance just because the two attorneys are withdrawn and a new attorney for petitioners has recently entered his appearance. The parties are to be ready for trial in accordance with the Court’s May 3, 2013, order.” Order, at p. 1.

Come in from the bullpen ready to pitch.


In Uncategorized on 09/25/2013 at 17:43

The immortal words of Starfleet Surgeon Commander Leonard (“Bones”) McCoy to Starfleet Captain James T. Kirk echo in Promissory Note Acquisition Company, LLC, Jack D. & Lisa J. Traeger, Partners Other Than The Tax Matters Partner, Docket No. 27468-12, filed 9/25/13.

Apparently the tax matterer in Jack and Lisa’s deal is dead, so according to Judge Paris, “is, therefore, no longer eligible to serve as tax matter partner. Section 301.6231(a)(7)-1(1)(1)(i), 301.6231(a)(7)-2(a), Proced. & Admin. Regs.” Order, at p. 1.

No successor has been chosen, so Jack and Lisa want a time out.

Judge Paris examines the role of the tax matterer: “Under the statutory provisions set forth in I.R.C. section 6221 et seq., the presence of a tax matters partner during litigation before this Court is essential to the fair, efficient, and consistent disposition of partnership proceedings. The tax matters partner must keep each partner informed of all proceedings relating to the adjustments of partnership items at the partnership level. Computer Programs Lambda, Ltd. v. Commissioner, 90 T.C. 1124, 1126 (1998). It therefore follows that to continue with this litigation, it is essential that a tax matters partner be appointed.” Order, at p. 1.

Remember poor Beverly Bernice Bang? See my blogpost “Bang – A Warning to Tax Matters Partners (and their advisors)”, 1/5/11. Tax matterers have to tell all their partners what’s happening with the litigation, and stay on top of it.

So Judge Paris gives Jack and Lisa a time out, during which Jack and Lisa must “file a Motion to Appoint Tax Matters Partners, either setting forth the name and address of the successor tax matters partner, or, if one has not been chosen by the partnership, setting forth the names, addresses, and members who can be designated managers and who are eligible to be appointed tax matters partner.” Order, at p. 2.

And check out the cited Regulation for how to do it.

Of course IRS gets a chance to respond or object to the motion.


In Uncategorized on 09/24/2013 at 17:57

Taking his lead from Paul Simon’s 1966 hit, that’s Judge Lauber’s direction to the SO in Thomas Szekely, 2013 T. C. Memo. 227, filed 9/24/13.

Tom filed his returns but couldn’t pay his taxes. The Taxpayer Advocate suggested Tom be placed in not currently collectible, but IRS said no, filed an NFTL, and Tom filed for a CDP, attaching all the documentation he had compiled.

Although Tom filed well within the thirty-day limit for a CDP, it took IRS four months to acknowledge Tom’s request.

Judge Lauber: “Finally… a settlement officer (SO) from the IRS Appeals Office acknowledged receipt of petitioner’s Form 12153 and notified him that she had scheduled a telephone CDP hearing for February 23, 2012. In the letter, the SO informed petitioner that, if he wished her to consider an offer-in-compromise (OIC) or other collection alternative, he should submit, before the scheduled CDP hearing, a completed Form 433-A together with supporting documentation and three months of bank statements. The letter made clear that the SO could not consider collection alternatives without receiving these documents. The SO gave petitioner 14 days from the date of her letter to provide the required information.

“Petitioner timely complied with the SO’s request and submitted all of the required documentation by letter…. In that letter, petitioner clearly outlined his financial situation. He informed the SO that he could not stay current on his… obligations without a compromise of his [past] tax obligations.” 2013 T. C. Memo. 227, at p. 4.

Tom called the SO, left a message, got a callback and was told to submit a Form 433-A(OIC). The SO said she would mail Tom an instruction packet.

She did, but her letter said nothing about 14 days or what would happen if Tom didn’t provide the Form 433-A(OIC).

Tom didn’t reply by day 14, so the SO recommended confirming the Lien on Day 15 and her manager confirmed it a week later.

Tom testified that if he’d been told the SO had to have the From 433-A(OIC) on Day 14, she would have. Anyway, Tom sent everything in on day 24.

“Almost six months later…the IRS informed petitioner that it was unable to process the OIC that he had submitted on [Day 24]. The reason given was that petitioner had failed to provide a Form 433-A (OIC) as requested. The IRS accordingly closed its file on petitioner’s OIC request.” 2013 T. C. Memo. 227, at p. 6.

Judge Lauber goes through the NFTL litany, the litany for the standard of review when liability for the tax is not an issue, and concludes: “Superficially, the SO would not appear to have abused her discretion under these circumstances.” 2013 T. C. Memo. 227, at p. 9.

Hold off the righteous anger, readers. Let’s welcome Judge Lauber (see my blogpost “Acceuillons, Let’s Welcome, Judge Albert G. Lauber”, 2/5/13).

Judge Lauber is troubled. IRS’ counsel says that for CDP the Section 7502 “timely mailed is timely filed” is not the rule. That means if it took a few days for Tom to get the package and a few days for his reply to hit the SO’s desk, Tom had three or four days to deal with a complex form. Presumably Tom was also working for a living at the same time.

While Tax Court has approved of the 14-day limit to provide information, there has to be a rule of reason. Surely Tom should get an extra couple of days.

Judge Lauber again: “…we are troubled by the contrast between the IRS’s sluggishness in responding to petitioner’s request for a CDP hearing and its alacrity in closing the case. It took the IRS four months to acknowledge receipt of petitioner’s request for a hearing, yet only one day for the SO to conclude that his case should be closed because he had missed a deadline. This strikes us as a double standard.” 2013 T. C. Memo. 227, at p. 10.

I cannot say how it strikes me, if I am limited to using language fit for a blog meant for family reading at the dinner table.

“…in exercising her discretion, a settlement officer should take into consideration the entire context of the case. Until his final footfault, petitioner had manifested timeliness and good faith in all his dealings with the IRS….. The SO knew that petitioner’s liabilities were properly reported; that he had previously worked with TAS to receive assistance; that he was eager to work out a compromise of his tax liabilities; that he was current on his [current] tax liability; and that he had responded timely to her previous requests for documents and information. Armed with this knowledge, the SO should not have lightly assumed, when petitioner’s OIC package did not arrive on [Day 14], that he had decided to walk away from his efforts to secure a compromise. We would hope that the IRS would reach out to a taxpayer in these circumstances and assist him in his tax compliance efforts, rather than proceed to close his case the day after a deadline passes. All that was required was a two-minute phone call to inquire whether petitioner needed a little more time.” 2013 T. C. Memo. 227, at pp. 10-11. (Footnote omitted, but read it; failing to grant a reasonable extension of time “would be an abuse of discretion”).

Judge Lauber to the rescue: “Although we cannot substitute our judgment for that of the SO… our review of the overall record leaves us with a firm sense that petitioner has not been treated in a fair and rational manner. We will therefore remand the case for a supplemental CDP hearing to consider petitioner’s OIC. Before the supplemental hearing, petitioner may submit a revised OIC on Form 656 accompanied by a Form 433-A (OIC) with current financial information. If petitioner is dissatisfied with the outcome of the supplemental hearing, he may pursue further review in this Court.” 2013 T. C. Memo. 227, at pp. 11-12. (Citations omitted).

Way to go, Judge Lauber.


In Uncategorized on 09/24/2013 at 06:51

No, not the memorable saying of  baseball immortal Leroy Robert (“Satchel”) Paige, to whom is ascribed “Don’t look back, they might be gainin’ on you”, but rather Tom Reed, 141 T. C. 7, filed 9/23/13.

Tom wants IRS to consider an OIC he put in years before the CDP from which he now petitions. He argues IRS should consider the old, returned OIC. IRS says (a) they don’t have to and (b) Tax Court has no jurisdiction to decide whether they have to or not, because Tax Court can only review a new OIC, not an old one that was never petitioned.

Now there are two ways IRS can bounce an OIC: one is to reject it, the other is to return it. Returns are unprocessable, here because Tom wasn’t current with his taxes when submitted, and that bounces an OIC regardless of liability, collectibility, or effective tax administration issues. Rejections are based on consideration of the OIC on the substantive grounds just mentioned. “Briefly, a taxpayer has the right to administratively appeal the Commissioner’s rejecting an OIC but has no right to appeal the Commissioner’s returning an OIC.” 141 T. C. 7, at p. 6, footnote 5.

Tom made two offers. The first, in 2004, was rejected because Tom dissipated assets. Tom tried again, in 2008.

Here’s Judge Kroupa: “The offer unit returned the 2008 offer to petitioner as unprocessable. Petitioner then exchanged several letters with the offer unit. Petitioner attempted through the letter exchange to have the offer unit reconsider its returning the 2008 offer. To this end, petitioner argued that he was in fact in compliance with his Federal income tax obligations at the time he submitted the 2008 offer. Petitioner also argued in the letter exchange that he should be given the opportunity to become compliant if, in fact, he was not at the time he submitted the 2008 offer. Petitioner continued to make payments during the pendency of the letter exchange consistent with the 2008 offer. The letter exchange ultimately failed, however, to convince the offer unit to alter its decision to return the 2008 offer to petitioner.” 141 T. C. 7, at p. 6 (Footnote omitted).

Judge Kroupa blows off the IRS’ jurisdictional arguments: “Respondent argues this Court lacks jurisdiction because petitioner proposed no new OIC during the collection hearing and the Court therefore has nothing to consider. Respondent also argues this Court lacks jurisdiction because petitioner has no right of judicial review of respondent’s rejecting the 2004 offer or returning the 2008 offer. We are perplexed by the arguments that respondent raises as they appear to miss the thrust of the theories petitioner advances. Moreover, it is fundamental that we have jurisdiction in collection matters if the Commissioner issues a determination notice and a taxpayer timely files a petition. Both conditions apply here. Accordingly, we have jurisdiction to review the determination….” 141 T. C. 7, at pp. 8-9 (Citations omitted).

OK, let’s cut to the chase.

Tom says the AO must consider the 2008 OIC based on the facts then existing. IRS says no; while Section 7122(a) gives IRS discretion to compromise taxes due, IRS still has to collect all taxes due. A taxpayer has a right to a CDP before IRS can levy to collect, but has to propose an acceptable alternative to the levy.

Tom wants IRS to consider a three-year-old alternative today. That would impermissibly expand IRS’ statutory authority; caselaw holds taxpayers must submit current financial data at a CDP. See also IRM, Oct. 2, 2012). Numbers must be no older than six months.

What Tom wants is review of a returned OIC, and that’s off the table. “Taxpayers may currently seek administrative review of the Commissioner’s rejecting an OIC. Sec. 7122(e). Taxpayers currently have no right, however, to seek review of the Commissioner’s returning an OIC. Sec. 301.7122-1(f)(5)(ii), Proced. & Admin. Regs. The theory petitioner advances would, in effect, create additional layers of administrative and judicial review of the Commissioner’s returning an OIC before a collection hearing commences. See sec. 6330(d). Petitioner’s theory would not create analogous layers of review, however, for the Commissioner’s returning an OIC after a collection hearing concludes. See id. Whether a taxpayer may access these new layers of review would therefore depend on when the Commissioner returns an OIC. Petitioner offers no, and we can find no, reasonable explanation for such disparate treatment based only on when the Commissioner returns an OIC.” 141 T. C. 7, at p. 13.

Tom dissipated assets, so the 2004 OIC is out, and he hadn’t paid his estimateds when he put in the 2008 OIC, so that’s out.

Tom, you’re out.


In Uncategorized on 09/23/2013 at 20:41

But Even If You Do, You Can Deduct The Interest

Too many players on the ice, when Bank of New York Mellon Corporation, As Successor In Interest To The Bank of New York Company, Inc., 2013 T. C. Memo. 225, filed 9/23/13, fields fifteen (count ‘em, fifteen!) lawyers against only six for the IRS. Guess that sequester really hurts, guys. But six of those fifteen Mellon lawyers leave after the trial.

At the close of play,  the point of Judge Kroupa’s Supplemental Memorandum Opinion is about borrowing, and the consequences of a deal lacking in economic substance. You may remember Mellon got slugged when they played Barclays Bank’s famous STARS game. See my blogpost “STARS Fell”, 2/11/13, for particulars.

My comment at the time was that coupling a legitimate transaction with a phony tax dodge doesn’t legitimatize the tax dodge.

But Mellon’s fifteen lawyers claim that decoupling the legitimate from the illegitimate still means Mellon should get whatever deductions the legitimate part of the deal threw off. IRS says no, so Judge Kroupa is dealing with a Rule 161 reconsideration.

The Mellon 15 agree that the STARS deal was a sham.  And Judge Kroupa found back in February that when you collapse the phony trusts and imaginary sales agreements and credit default swaps, you get a $1.5 billion loan from Barclays to Mellon at one-month LIBOR plus 20 bps.

Barclays, of course, was one of the prime manipulators of LIBOR.

The Mellon 15 say they want a deduction for that interest, because Mellon really borrowed the money and really paid interest at that rate.

Judge Kroupa: “We held in BNY I [the February sham case] that the STARS transaction should be bifurcated into the STARS structure and the loan for purposes of determining whether the economic substance doctrine barred petitioner from claiming the foreign tax credits and the foreign tax expense deductions for the years at issue. Accordingly, we analyzed the economic substance of the STARS structure separately from the loan. We held that the STARS structure lacks economic substance and that petitioner was not entitled to the interest deductions it had effectively taken on the loan because the interest expense was incurred in furtherance of a transaction lacking economic substance.” 2013 T. C. Memo. 255, at p. 6.

Now we all know that Rule 161 isn’t a free chance to rehash old arguments, and Mellon did have a chance to make at least some of the arguments they’re making here. But although reluctant, Judge Kroupa feels the need to discuss the non-phony part of the deal.

The Mellon 15 argue that Mellon actually got the money, it was available for Mellon to lend out, and Mellon actually paid interest. Therefore said interest should be deductible under Section 163(a). In fact, Tax Court has held that a real debt to finance a phony deal gives rise to an interest deduction; but since this case gets appealed to Second Circuit, that won’t fly, as Second Circuit has shot that one down.

However, in this case, say the Mellon 15, the loan proceeds weren’t used to fund the phony deal. IRS says no, you were going for two tax benefits, and the phony one (the UK tax credits) taints the whole deal.

No, says Judge Kroupa: “Petitioner did not use the loan proceeds to finance, secure or carry out the STARS structure. The loan was not necessary for the STARS structure to produce the disallowed foreign tax credits. Rather, the loan proceeds were available for petitioner to use in its banking business throughout the STARS transaction. Accordingly, the loan served a purpose beyond the creation of tax benefits….” 2013 T. C. Memo. 255, at p. 11.

But the interest is inflated, says IRS; Mellon could have borrowed cheaper in the open market.

So what, asks Judge Kroupa: “Respondent also argues that because petitioner could have obtained a loan at a lower cost in the market place, the loan interest deductions must be denied. We disagree. We have held that a grossly mispriced asset or negative cashflow can contribute to the overall picture of an economic sham. Nevertheless, interest accruing on a real loan that is used for economically substantive activity is deductible under section 163(a) even if the borrower is also motivated by favorable tax consequences. Despite being overpriced, the loan proceeds were available for use in petitioner’s banking business. Accordingly, we hold that petitioner is entitled to deduct the interest that accrued on the loan for the years at issue.” 2103 T. C. Memo. 255, at pp. 11-12. (Citations omitted).

Economic substance (a/k/a sham transaction) is all of a piece. “We have held that the economic substance doctrine cannot be applied selectively to certain consequences of a transaction. Instead, we have given effect either to both the cost and income functions of a transaction or to neither when applying the economic substance doctrine.” 2012 T. C. Memo. 255, at p. 15.

So some consequences of the bogus STARS deal are removed from Mellon’s tax return.

A Taishoff “good try” to the Mellon 15. But I’d like to see what Second Circuit does with this, if IRS elects to appeal. No one disputes the loan was made at an above-market rate. While one might bifurcate the loan and the tax dodge to analyze them, I’d argue one cannot divorce them entirely. The loan was an integral part of the dodge; but for the dodge, Mellon would never have made that loan deal with Barclays. I doubt Mellon’s credit was so poor they had to pay above the odds. I’d argue the above-market interest rate was additional compensation to Barclays for facilitating the dodge. If a colorably legitimate transaction is made to facilitate a dodge, even though not to finance it directly, is the colorably legitimate portion of the deal thereby rendered completely legitimate?