When it comes to taking a deduction for a loss. Judge Chiechi gives a pointed example of this well-known doctrine in Duquesne Light Holdings, Inc. & Subsidiaries F.K.A. DQE, Inc. & Subsidiaries, 2013 T. C. Memo. 216, filed 9/11/13.

Duque was in the business of lighting up Pittsburgh, PA and environs, but got into the water business, both fresh and waste. However, Duque discovered that water was entirely a waste, and wanted to bail therefrom.

Duque had used an indirect, wholly-owned subsidiary, with which it reported on a consolidated basis, named AquaSource, Inc., to conduct its watery dealings. Using a wholly owned direct subsidiary, Duque funneled cash and Duque stock into AquaSource and took back AquaSource stock.

Then, after the water business was under water, Duque unloaded some of its AquaSource stock to Lehman Bros. Holding for a pittance, representing money that Duque owed Lehman for other services, and took a girnormous loss. Duque carried back the loss and got a $35 million refund.

Then Duque sold off the assets of AquaSource and claimed another ginormous loss.

IRS, ever the spoilsport, shoots down Loss Number 2 thus: “Since the consolidated group recognized a loss on the… disposition of approximately 4% of the AquaSource stock, which loss was attributable to the fact that there was built-in loss in the underlying assets of AquaSource, the consolidated group is not permitted to take the duplicative losses when the underlying assets were sold in 2002 and 2003. Accordingly, the portion of the asset sale losses that are duplicative (determined by application of a ratio consisting of the loss claimed on the stock sale over the potential duplicative loss… against the losses claimed per asset sale) should be disallowed by application of the doctrine of Charles Ilfeld Co. v. Hernandez, 292 U.S. 62 (1934).” 2013 T. C. Memo. 216, at p. 11.

In other words, the price of the stock was depressed by the value (or lack thereof) of AquaSource’s assets. That depressed price permitted Loss Number One, and that’s all you get, Duque, so when you unloaded the assets themselves, no more losses. And the stock “sale” was a payoff to Lehman Bros Holding.

While Duque’s case was wending its way through Tax Court, Tax Court decided Thrifty Oil Co., 139 T. C. 198 (2012). As Gerdau Macsteel was decided the same day (8/30/12; see my blogpost “MacSteal”, 8/30/12), Thrifty Oil evaded my eagle eye, so I have no blogpost to point to.

Thrifty holds you can’t double-dip if you’re a consolidated group, and Duque filed a brief amicus therein. So Judge Chiechi asks Duque and IRS to file briefs stating why Thrifty does or doesn’t settle Duque’s case.

They do, and it does. Notwithstanding Duque’s arguments, which duplicate those in their amicus brief in Thrifty, unless you can show an explicit statutory provision allowing a double deduction, once is enough.

And some Third Circuit learning on which Duque relies expressly provides that the Ilfeld “double-dip” rule applies expressly to corporations reporting on a consolidated basis. In a consolidated group, if all members gain, the tax is the same. But where one gains and another loses, the loss cannot already have been taken by a member of the group. Duque’s argument that Section 165 permits the double-dip loses, because Section 165 is a general provision allowing losses to be deducted, doesn’t get it either; it isn’t specific to this kind of case.

Enough.

Not, not the television game show, but the games played by Bruce E. Phillips, 2013 T. C. Memo. 215, filed 9/10/13, as told by Judge Morrison. Mr. Phillips claims he didn’t make any dollars, only took losses.

Mr. Phillips got hit with a $3400 deficiency for the year at issue, which he petitioned. He claimed he was bowling for dollars, and these were business expenses. He had claimed other business expenses, but IRS didn’t mention those in the SNOD.

Judge Morrison: “…the IRS sent Mr. Phillips a letter requesting documents establishing that Mr. Phillips was engaged in the trade or business of bowling… and that Mr. Phillips was entitled to the deductions he claimed on his Schedule C. The letter requested that Mr. Phillips mail these documents to the IRS….

“…the parties spoke on the phone. Mr. Phillips stated that he would provide documents only to a Tax Court Judge. The IRS informed Mr.  Phillips that it would seek to amend its answer to assert that all deductions claimed on his Schedule C should be disallowed.” 2013 T. C. Memo. 215, at pp. 5-6.

Would it be mere surplusage to point out to Mr. Phillips and others similarly situated that the answer he gave was an invitation to get hammered?

And of course, “(A)t the end of the trial the IRS moved to amend its answer to assert that all of Mr. Phillips’ claimed Schedule C deductions should be disallowed and to assert that Mr. Phillips is liable for the accuracy-related penalty. The motion calculated that the deficiency is $5,800, the understatement is $5,800, the tax required to be shown on his return is $8,388, and the penalty is $1,160.” 2013 T. C. Memo. 215, at p. 8.

Judge Morrison finds no unfair surprise. Even though Mr. Phillips is not a lawyer and doesn’t know to object when IRS wild-cards into evidence that which is at variance with the pleadings, he did know IRS was going to shoot down all his deductions and nail him with the five-and-ten (10% or $5000 understatement of tax). He says he didn’t know that the penalty was 20% of the tax due, but Judge Morrison doesn’t care; Mr. Phillips had plenty of time to prepare a defense.

Except that Mr. Phillips hadn’t made money from bowling in seven years, flunked all but one of the Section 183 trade-or-business-for-profit tests (and the one he didn’t flunk was neutral), and had only seven pages of bank statements to support his claimed expenses, except they didn’t.

“The underpayment is also due to negligence. Mr. Phillips was negligent in claiming business expenses for his bowling activities. He made no effort to comply with the Federal income tax laws. He did not maintain any records. He admitted that at least some of his reported expenses were related to bowling. He was unable to point to expenses related to bowling. He provided no evidence to substantiate any of his claimed expenses.” 2013 T. C. Memo. 215, at p. 31. I think Judge Morrison meant that Mr Phillips admitted some of his expenses were unrelated to bowling.

Best of all is the claimed Section 6664 good-faith reliance. “Mr. Phillips credibly testified that he went to a tax return preparer for his…return, but that he provided the preparer with only the seven pages from bank statements that he provided to the IRS and introduced at trial. The preparer refused to sign the return because he was afraid of an audit. A reasonable and prudent person would not have disregarded a tax return preparer’s warnings without making at least a minimal effort to ensure there was some legal basis for doing so.” 2013 T. C. Memo. 215, at p. 31.

Ya can’t make this stuff up.

 That’s Judge Halpern’s lesson for Reginald Sampson and Gervel S. Sampson, a.k.a. Gervel S. Jones, in 2013 T. C. Memo. 212, filed 9/9/13.

Reg had two Sub Ss for his successful medical practice, and saved all his ledgers on QuickBooks, which his trusty accountant Bedig could access when preparing Reg’s and Gerv’s Forms 1040 and the Sub Ss 1120Ss. But being careful, Bedig wanted the hard copy back-ups. Problem was, claims Reg, his offices were being renovated and the back-ups were in storage and unavailable.

Bedig kept after Reg, but got nothing, so Bedig prepared the 1040s for the years at issue, but not the 1120-Ss. He did note on the 1040s that the pass-through items from the 1120Ss weren’t included, but would be furnished as soon as available. Bedig didn’t attach Form 8275 to the 1040s for either of the years at issue.

Now some say an 8275 is an immediate “please audit me” request. Maybe so, but IRS didn’t need an 8275 to audit both years, and nail Reg and Gerv. When the audit notice arrived, somehow the back-ups did, too, so Bedig prepared the 1120Ss, and 1040Xs, and sent them in.

Reg and Gerv owe tax big-time, and pay, but want to fight the penalties.

First, they claim their 1040Xs were qualified returns, within the meaning of Regulation section 1.6664-2(c)(3).

Judge Halpern: “Even if we were to disagree that the regulations are substantial authority for their treatment of the corporate income, petitioners argue that their understatements should be reduced or even eliminated because, pursuant to section 1.6664-2(c)(2), Income Tax Regs., the overall tax amounts shown on what they consider to be their returns include the additional corporate income shown on their ‘qualified amended return[s]’, as that term is defined in section 1.6664-2(c)(3), Income Tax Regs.” 2013 T. C. Memo. 212, at pp. 10-11.

No they aren’t, say IRS and Judge Halpern, because the 1040Xs weren’t filed until after the IRS sent the audit notices. Repentance comes too late. So no substantial authority for the underpayments.

In any event, they didn’t properly file Form 8275 for either year at issue, thus reasonable basis plus disclosure doesn’t work.

Unlike Dave Bauer, whose poor records were enough to get him off the negligence penalty (see my blogpost “The Truckdriver Shifts”, 6/4/12, for more about Dave Bauer), Reg and Gerv had records, and no reasonable basis not to estimate from what they had. They knew they’d had substantial income from their Sub Ss in past years.

It’s true that Bedig told Reg and Gerv he wasn’t putting in anything from the Sub Ss. So they might have assumed that they didn’t need to do more.

Except (and it’s a big except) “…Dr. Sampson was an experienced taxpayer. He was aware of the statement on each original return that he was signing under penalties of perjury and declaring that the returns ‘were true, correct, and complete.’ He knew that, with respect to pass-through items from the corporations, the original returns were, to say the least, not complete. He knew that, in years past, he had reported substantial income from the corporations. He had available to him the QuickBooks from which he, or [Bedig], could have estimated income from the corporations. Petitioners have not convinced us that, even if they understood [Bedig] to have been telling them that it was okay to omit income from the original returns, they had a reasonable basis to do so and that they acted in good faith in failing to estimate and report income from the corporations.”  2013 T. C. Memo. 212, at p. 23. (Name omitted).

Penalties affirmed.

Takeaway– Estimate and disclose, then amend in a hurry.

 You’ll remember, maybe, my early blogposts about the impossible Tax Court admission examination; if you don’t, no problem, just see my blogposts “A Book And A Modest Proposal”, 5/22/12, and “Another Argument”, 6/7/12, anent the murderers’ row that is the Tax Court admissions examination.

But Judge Halpern likes tough questions. And I wonder how many attorneys, to say nothing of Tax Court practitioners and would-be admittees, can provide passing answers to the conundra Judge Halpern volleys at IRS’s counsel John Schmittdiel, Esq., (who I dare say never did Judge Halpern any harm) in Stephanie Lynn Christie A.K.A. Stephanie Lynn Foran, Petitioner,  and John Foran A.K.A. Arthur J. Maurello, Intervenor, Docket No. 24515-12S, filed 9/6/13.

It’s a run-of-the-mill Section 6015 joust over who’s responsible for what part of the income taxes for the year at issue, until John F. a.k.a. Arthur J. throws in a curveball. The State court  divorce decree and judgment that separated Stephanie Lynn from John F a.k.a. Arthur J. supposedly says who carries whose burdens taxwise, and John F. a.k.a. Arthur J. says Stephanie Lynn is estopped to claim otherwise.

So John F. a.k.a. Arthur J. moves for summary J., and Mr. Schmittdiel, representing IRS, has no objection. Stephanie Lynn says nothing.

But Judge Halpern has plenty to say. “Respondent [IRS] was not a party to the proceeding giving rise to judgment. We have, on numerous occasions, held that the Commissioner is not bound by a provision in a divorce agreement allocating tax liability. See, e.g., Pesch v. Commissioner, 78 T.C. 100, 129 (1982). Moreover, in Bruner v. Commissioner, 39 T.C. 534 (1962), concerning the allocation of dependency exemptions to divorced spouses, we held that we are not bound by a community property settlement approved by the divorce court.”

It’s already a bad day for family law attorneys, and it doesn’t get much better, even for IRS counsel.

Judge Halpern asks Mr. Schmittdiel to consult the High Command at IRS National Office as he answers the following Bar exam questions: “May an intervenor move for summary adjudication in a proceeding brought pursuant to section 6015(e)? If so, does intervenor present an issue for which there is no genuine dispute as to any material fact and with respect to which a decision may be rendered as a matter of law? See Rule 121(b), Tax Court Rules of Practice and Procedure. In answering the last question, discuss whether interpretation of the judgment presents an issue of fact. If the issue presented by intervenor is ripe for summary adjudication, does petitioner’s claim for relief in this proceeding raise any issue identical to an issue decided in the judgment, by the State Court? If so, are the other elements of collateral estoppel satisfied? If they are, what is the issue and what effect does it have on us to determine the appropriate relief we may accord petitioner under section 6013(e)[sic; should be 6015(e)]. Respondent may address any other issues that he deems relevant.” Order, at p. 2.

Oh yes, answers are due by October 9. I presume neatness counts, and briefing page limits apply. Mr. Schmittdiel, I feel your pain.

On another note, I see  Ch J. Thornton  transferred a barrelful of cases from Judge Gustafson to Judge Laro today. I hope all is well with the Obliging Judge.

 Unless Your Partner Isn’t Your Partner

Judge Wherry can’t shake John E. Rogers, tax whiz and DADs promoter; see my most recent blogpost “There Goes The Neighborhood”, 9/3/13, where Judge Posner of Seventh Circuit decries Judge Wherry’s whimsy but slugs Mr. Rogers nevertheless. I’ve discussed Mr. Rogers’ multifarious and nefarious doings numerous times.

But today Mr Rogers is playing second fiddle to Mr. Timothy J. Elmes in Sugarloaf Fund LLC, Jetstream Business Limited, Tax Matters Partner, 141 T. C. 4, filed 9/5/13. Tim’s main trust and sub-trust were loaded up with bits and pieces of Mr. Rogers’ Brazilian IOUs, courtesy of Mr Rogers’ creation Sugarloaf, LLC.

Clear? Thought not.

Howbeit, Tim claims a Section 166 bad debt deduction based on the Brazilian paper, which IRS claims is worthless and always was, tosses the deduction and hands Tim a SNOD, which Tim doesn’t petition, so Tim tries to cut in on the Sugarloaf FPAA, claiming he’s an indirect partner of Sugarloaf.

Judge Wherry is very un-whimsical: “This Court has for some time, even predating Mr. Elmes’ attempt to intervene in this case, been concerned as to whether ‘individual U.S. investors who claimed to have purchased ownership interests in the Holding Companies as well as those who acquired beneficial interests in the Sub-Trusts’ had ‘the right to participate in these partnership-level proceedings’. This Court’s order dated April 17, 2012, discussed these issues in some detail and directed the parties to file briefs addressing these issues. Both petitioner and respondent have, in response to the Court’s order, filed briefs addressing these issues. After careful consideration, we have concluded that Mr. Elmes is not a direct or an indirect partner in Sugarloaf within the meaning of section 6226(c) or 6231(a)(2). Consequently, he may not participate in this case, and we will deny his outstanding motions as moot….” 141 T. C. 4, at pp. 3-4.

For more about the April 17, 2012 Order above-cited, see my blogpost “Mr. Rogers Tries Again”, 4/17/12.

So what’s the story with Tim? He’s not a partner, direct or indirect, at least for the year at issue.

Tim has K-1s for the two years subsequent, but can’t produce one for the year at issue. “Nor does Mr. Elmes contend he or his trusts banded together with the Brazilian retailers, Warwick, and Jetstream to jointly conduct, through the Sugarloaf partnership, a common undertaking. Therefore, Mr. Elmes has not demonstrated that either he or the Elmes Sub-Trust was a direct partner of Sugarloaf for 2005. Thus, in order for Mr. Elmes to participate in this case, he must be a ‘person whose income tax liability… * * * is determined in whole or in part by taking into account directly or indirectly partnership items of the partnership.’ Sec. 6231(a)(2)(B).” 141 T. C. 4 at p. 9 (Citations and footnote omitted).

While some are partners for TEFRA purposes, like spouses or common parent of a consolidated group where one subsidiary is a partner, and some are “pass-thru” partners, Tim is none of the above, as he had no interest in Sugarloaf in the year at issue.

Tim’s beef is that his deficiency depends on the value of the Brazilian junk he got from Sugarloaf, so he’s a partner in Sugarloaf.

No, says Judge Wherry, “…if the argument were correct, then any trust to which a partnership transferred assets would be a member of that partnership. We do not believe that a trust is necessarily a partner of a partnership merely because the trust received assets from that partnership, and we do not accept Mr. Elmes’ expansive interpretation of section 6231(a)(2)(B).” 141 T. C. 4, at p. 13.

Tim got assets, not a partnership interest, directly or indirectly. And while it might be nice if the value of the Brazilian junk was determined once for all and for everyone, the IRS need not be consistent unless the statute requires it, and here it doesn’t. Anyway, Tim has no standing in the Sugarloaf FPAA. He should have petitioned the SNOD.

Had enough about non-partners? There’s more. Judge Morrison has something to say in Philip D. Long A.K.A Phil Long, Docket No. 26552-10, filed 9/5/13.

Phil was building a condominium, but hit a snag and sued the counterparty to his contract. He promised a third party, with the fetching name “Steelervest”, $875K from the earlier to occur of winning or settling the lawsuit or building and selling the condominium units.

Phil got $5.75 million for what Judge Morrison calls the “sale” of the lawsuit; how you sell a lawsuit is also interesting, but let’s assume he meant “settlement”. Phil paid Steelervest $800K, and Steelervest released Phil from his promise.

Phil claims he and Steelervest had a joint venture as regards the condo, so the $5.75 million he got out of the lawsuit belongs in part at least to Steelervest.

IRS says no, it’s all yours Phil. And Phil and IRS go to trial.

The interesting part is that, post-trial, IRS moves to amend their pleadings to conform to the proof that, since Phil promised Steelervest $875K but only gave them $800K, Phil was relieved of indebtedness to the tune of $75K.

No, says Judge Morrison. “Under Rule 41(b)(1), the Court may allow such amendment of the pleadings as may be necessary to cause them to conform to the evidence when an issue not raised by the pleadings are tried by express or implied consent of the parties. Undue prejudice to the other party, because the party had insufficient notice of the issue to be raised, is a key factor in deciding whether to allow an amendment to the pleadings under Rule 41(b)(1).

“Long was not notified of the cancelled-debt theory until the IRS made its motion at the end of trial. Evaluating the merits of the cancelled-debt theory conceivably requires evidence other than the evidence relevant to the other issues at trial, such as the existence or nonexistence of a joint venture with Steelervest. Therefore, Long was unduly prejudiced by the IRS’s failure to plead the cancelled debt theory.” Order, at p. 2-3. (Citations and footnote omitted).

And here’s the omitted footnote: “If Long’s relationship with Steelervest was not a joint venture, this does not necessarily mean that Steelervest was a creditor of Long. See Ewing v. Commissioner, 20 T.C. 216 (1953) (finding a joint venture did not exist and disallowing a deduction for worthless debt where repayment would be made out of operating profits).” Order, at p. 3, footnote 2.

Honor your partner, indeed.

For good health and prosperity, and interesting cases to blog and discuss.

 And Learn About Insurance, If You’re Interested

An alumnus of DePaulUniversity, its law school, and Georgetown University School of Law, Judge Nega joins the Tax Court bench today. Welcome, Judge.

And it’s a good day to join, as Judge Vasquez has presented us with ninety-eight (count ‘em, 98) pages of insurance company loss reserve actuarial analysis, in Acuity, a Mutual Insurance Company, and Subsidiaries, 2013 T. C. Memo. 209, filed 9/4/13.

Don’t worry, I’m not going through the whole nine yards here. In the first place, the case is well outside the range of matters encountered by the in-the-trenches tax preparer for whom I’m writing this blog.

In the second place, it’s a lot more about penguins than anyone but a fellow-penguin would want to know, and maybe not even them. But Judge Vasquez gives a good introduction to insurance accounting and taxation in relatively simple language. So you might want to read from around page 8 to page 17 for background, and beyond if it grabs you.

The numbers are huge, so that a win by IRS would result in a bushelbasketful of tax and a real hit to Acuity, a mutual insurance company out of Wisconsin.

For starters, the year-one deficiency is $1.1 million, but year-two rises to $31 million, and that got me a phonecall from Mr Patrick Temple-West at Reuters, thinking there’s a big story here.

Well, there really isn’t, as this is a case of dueling actuaries and a review of some obscure Code Sections. In short, insurance company deductions for reserves for losses is a “fair and reasonable” test. Acuity’s actuarial hotshots got the numbers close enough for National Association of Insurance Commissioners standards, and also the actuarial sciences people. IRS’ guys couldn’t show otherwise, despite a lapse in language by one of Acuity’s vice-presidents in a letter to A. M. Best, the insurance raters.

No startling legal theories, so nothing really exciting here. Unless you’re an actuary, that is.

And I have to compliment Acuity’s counsel; they really woodshedded their experts. See my blogposts “Woodshedding Your Experts – Stobie Creek Part Deux”, 1/10/11, and “Woodshedding Your Expert – Redivivus”, 8/6/13.

Yes, he’s at it again, Judge Mark V. Holmes, The Great Dissenter, a/k/a The Judge Who Writes Like A Human Being.

Today he has a double-header, first writing 2013 T. C. Memo. 207, James R. Dixon, filed 9/3/13, overturning IRS’ levy on Jim and wife Sharon’s home for unpaid income taxes (because they did pay, albeit late, and via their wholly-owned corporation, as withholding taxes). Judge Holmes reviews the history of the Dixons and Tryco, their corporation, and finds IRS can only collect once. The records for the relevant years are lost, so IRS claims  Jim and Sharon can’t prove what was supposed to be withheld. Judge Holmes, however, finds Jim’s and Sharon’s testimony, and such records as remain from their criminal cases (yes, they were convicted) credible, and knocks out the levy. Even though the years of the non-withholding are closed, Tax Court can review those years to ascertain how to deal with a year that is open. And IRS’ levy on Jim and Sharon’s home gets lifted as the tax was paid.

So far, so good.

But the second opinion finds The Great Dissenter dissenting, even though the majority, per Judge Lauber, holds for Jim and Sharon in 141 T. C. 3, filed 9/3/13.

Jim and Sharon had income tax liabilities arising from their employment by their wholly-owned C Corp Tryco. So did Tryco, for not withholding when it should. After Jim and Sharon get nailed for their various delictions, they borrow money against their home and send the money to Tryco (which is more or less out of business), which in turn remits checks to IRS with Forms 941 and letters directing IRS to apply payments to Jim’s and Sharon’s withholding. But these are for the restitution and tax loss sustained by the government on account of Jim and Sharon’s criminal convictions.

IRS did, but then changed its mind, relying on the “withheld at the source” language of Section 31, and these payments clearly weren’t, and also mindful of the $23 million in payroll withholdings Tryco still owes.

IRS says an employer can’t allocate late withholdings to individual employee-taxpayers, but Judge Lauber says no, and cites a number of reclassification cases, where the employer can pay the tax as to one member of an employee class and sue for a refund, to challenge the reclassification of all members. Withholdings are “divisible” taxes, that is, allocated to a particular individual account.

Now the Section 6205 adjustment period for underwithholdings is long past for the years at issue. So Jim and Sharon don’t get the benefit of the Section 31 “even if not paid by the employer” credit for the late paid withholding.

But Judge Lauber and the majority do allow the credit for the designated payments made late by Tryco. IRS argues Tax Court has no jurisdiction over employment taxes. True, says Judge Lauber, but these are income taxes for Jim and Sharon. The amounts paid are not at issue; crediting them is.

Now this is a levy case, so either de novo or abuse-of-discretion applies, but either way, IRS must credit the payments as Tryco directed.

IRS’s general policy is that voluntary payments (and these were, even though Jim and Sharon made them as part of their criminal plea deal) must be credited as the taxpayer directs. And there’s much precedent to support this. For further details read Judge Lauber’s opinion.

And the policy prevents IRS from double-dipping–collecting the same tax twice, as in TFRPs and withholdings. To the extent the employee has paid the tax, the TFRP penalty is abated. This is so even if the Code does not provide explicitly.

Now of course Jim and Sharon owe interest and penalties. The late payment doesn’t wipe that out, as the taxes were not withheld “at the source” or within the correction timeframe of Section 6205. IRS can levy for those, if it wishes.

And Judge Lauber is not discussing any of Tryco’s tax incidents from this arrangement, or whether the payment by Tryco is additional compensation to Jim and Sharon.

Judge Goeke concurs, but points out that the majority rules on the law. Judge Holmes found the facts in 2013 T. C. Memo. 207, and the majority is not going behind those findings, including without in any way in limitation of the generality of the foregoing, as the high-priced lawyers say, the credibility of Jim and Sharon. “The Court is also aware that James Dixon pleaded guilty to Federal tax evasion for 2006, United States v. Dixon, No. 4:12CR00521-001 (S.D. Tex. Apr. 1, 2013), the same year petitioners testified that they knew nothing about the nonpayment of withheld taxes for tax years 1992-95. Similarly, Sharon Dixon was also later convicted for subsequent Federal tax crimes. United States v. Dixon, No. 4:12CR00522-001 (S.D. Tex. Feb. 13, 2013).” 141 T. C. 3, at pp. 39-40. Apparently Judge Goeke, and Judges  Wherry, Kroupa, Morrison and Lauber are less than thrilled with the credibility of Jim and Sharon.

But Judge Holmes, not a whit dismayed, charges to the front. “Imagine that a check arrives at the IRS from John Green with a letter that says ‘This check is to be applied to my tax bill for 2013. Also, please credit my friend Joe Black’s account for the same amount. He gave me the money that let me write this check and I’d like him to benefit as well.’ If things work as they should at the Service, Green’s account should be credited; and the suggestion that the same check should be credited for Joe Black’s account would cause some tittering, or maybe just a puzzled look on the face of the IRS employee opening the envelope.” 141 T. C. 3, at p. 41.

Now Judge Holmes agrees with the majority that the Section 31 credit doesn’t apply here, or else Jim and Sharon would be off the hook for interest and penalties. But designated payments don’t help either, as Section 31 says the employee only gets credit where the wages were withheld at the source. So while Tryco’s payments bailed out Tryco, they do nothing for Jim and Sharon even though they supplied the money (presumably as a capital contribution) to Tryco.

Judge Lauber and the majority can’t override the clear statutory bar to crediting payments made after the Section 6205 self-correct period is over. Yes, there’s an asymmetry here, but Congress should fix it, not Tax Court.

“What colors these cases, and makes the Dixons look sympathetic, is that the money Tryco paid is money that the Dixons contributed to the corporation after they took out a home-equity loan for almost a half-million dollars. It was this money that they sent to Tryco, and had Tryco pay over to the IRS….The Dixons couldn’t have been much more clear… they told the IRS to pay the taxes “of the corporation,” the same entity that formally sent along the payment. The Dixons did ask the IRS to apply the payments to the portion of Tryco’s employment-tax bill that was attributable to Tryco’s failure to withhold taxes from James’s and Sharon’s wages. But that isn’t the same thing as asking the IRS to apply the payments directly towards the Dixons’ individual income-tax liabilities, because Tryco was asking the IRS to apply the payments toward a specific part of Tryco’s tax bill.” 141 T. C. 3, at pp. 43-44. (Emphasis by the Court).

Now let’s give a Taishoff “good try” to Larry Campagna, Esq., Jim’s and Sharon’s astute attorney. Larry testified he used the Tryco maneuver because “had Mr. and Mrs. Dixon remitted the income taxes directly for their account, then the 941 liability for Tryco would not have been reduced by the payment, and the Government would have been asking for a double collection of the same money on the income tax side and the employment tax side.” 141 T. C. 3, at p. 44.

No, says Judge Holmes, because Section 3402 would have credited Tryco for the payment Jim and Sharon made, but not vice versa.

But Larry was hunting bigger game than the $92K involved here. “By instead contributing the money to Tryco–their employer–and then having Tryco pay it as employment tax, the Dixons hoped that the IRS would treat the payments as the IRS treats normal withholding payments, which would then erase many years of interest and penalties.” 141 T. C. 3, at p. 45 (Footnote omitted, but read it; the interest was over $530K. And when Larry testified that he wasn’t worried about the interest when he planned this, Judge Holmes didn’t find “this particular part of his testimony credible”.)

Now for the big story: “The majority glosses over some of the other tax consequences of its decision today. The Dixons had to contribute $602,119 to Tryco because Tryco wasn’t doing much business anymore. The Dixons were controlling shareholders, and their capital contributions would have increased their bases in the Tryco stock. Tryco’s employment-tax burden is smaller to the extent of the payments that it made, but it is still so large that the company stock may still be worthless, manufacturing a tidy loss for the Dixons. When the Dixons eventually abandon or sell Tryco, they’ll get a bigger loss than they otherwise would have because of their increased bases.

“And we shouldn’t forget that Tryco was the Dixons’ employer. As the majority acknowledges… employers that pay their employees’ bills are treated as if they were paying wages instead….. But Tryco’s payments were in 1999 and 2000, meaning the Dixons have untaxed income for 1999 and 2000, years for which assessment is now barred by the statute of limitations (assuming that the Dixons began filing their tax returns on time). We also shouldn’t forget that paying wages–this time in the form of paying tax bills–also comes with its own withholding tax obligations for Tryco under section 3403, which it, once again, won’t have fulfilled.” 141 T. C. 3, at pp. 57-58. (Citations omitted).

Finally, with a really loud “good try” to Larry Campagna, Esq., : “The Dixons did what they did because they were swinging for the fences–they wanted to reduce Tryco’s employment-tax bill, reduce their own income-tax liabilities, bump up their bases in probably worthless Tryco stock, and use section 31 to erase many years of penalties and interest. I don’t blame them for trying–the law was, and after today, will remain, unclear.” 141 T .C. 3, at p. 59.

But Congress created the asymmetry–the employer gets the break when the employee pays late, but not the other way around. And Congress should fix that, not Tax Court. Judges Halpern and Buch agree.

As I was lamenting the absence of good material for this blog yesterday, along comes Judge Posner and the Seventh Circuit, who lays a beating on John Rogers and his DADs, along with a sideways slap at Judge Wherry, in Superior Trading, LLC, et al., v. Com’r, Nos. 12‐3367, 12‐3368, 12‐3369, 12‐3370 and 12‐3371, decided 8/26/13.

Judge Posner affirms Judge Wherry’s deconstruction of Mr. Rogers’ phony partnerships among US highrollers looking for writeoffs and a Brazilian retailer with bum paper. For background, see my blogposts “More Shell Games”, 9/2/11, “Mr. Rogers’ Neightborhood – The Adventure Continues”, 11/23/11, and “Night Of The Living Dead – Mr. Rogers’ Neighborhood”, 5/10/13.

So no deductions. Therefore penalties: but is it the 20% substantial understatement or the 40% substantial overvaluation? Of course, IRS wants the 40% hammer that Judge Wherry gave them, but that’s not cut-and-dried.

After all, if the deal was a sham from the get-go, then the valuation, over or under, is beside the point, no? See my blogpost “It’s A Sham – And That’s An Understatement – Not!”, 9/25/12.

No, says Judge Posner: “There is a disagreement among courts of appeals concerning the applicability of the penalties for misstating valuation when the transaction involving the overvalued asset is itself disregarded because it lacks economic substance. Compare, e.g., Crispin v. Commissioner, 708 F.3d 507, 516 n. 18 (3d Cir. 2013); Gustashaw v. Commissioner, 696 F.3d 1124, 1136–37 (11th Cir. 2012), and Fidelity Int’l Currency Advisor A Fund, LLC v. United States, 661 F.3d 667, 672 (1st Cir. 2011), with Keller v. Commissioner, 556 F.3d 1056, 1059–61 (9th Cir. 2009), and Heasley v. Commissioner, 902 F.2d 380, 383 (5th Cir.1990). The majority view, which we now join, is that a taxpayer who overstates basis and participates in sham transactions, as in this case, should be punished at least as severely as one who does only the former. The Supreme Court has granted certiorari to resolve the circuit conflict. United States v. Woods, 133 S. Ct. 1632 (2013).” Decision, at pp. 9-10.

And Judge Posner has little sympathy for the “partners” in Mr. Rogers’ deals. “The appellants would have avoided the penalty had they proved they had “reasonable cause” to deduct the built‐in losses. 26 U.S.C. § 6664(c)(1); see United States v. Boyle, 469 U.S. 241, 250–51 (1985); University of Chicago v. United States, 547 F.3d 773, 785 (7th Cir. 2008); Richardson v. Commissioner, 125 F.3d 551, 558 (7th Cir. 1997). They didn’t prove that. They were all just tools—extensions, really—of Rogers, an experienced tax lawyer who had more than 30 years of experience in the taxation of international business transactions. The tools had no more autonomy than his fingers. There is not even a colorable basis for the tax shelter that he created and the appellants implemented. There are as we’ve seen multiple grounds for disallowing the partnership losses that Rogers engineered (in fact more grounds than we’ve bothered to discuss), and all are grounds that he either knew about or should, given that he is no tax neophyte, have known about.” Decision, at p. 10.

Now, having affirmed Judge Wherry all along the line, Judge Posner waxes waspish, parenthetically: “(We note with disapproval the loquacity of, and lame attempts at humor in, the Tax Court’s opinion, which include making fun of Rogers’ name, as in the section title ‘Mr. Rogers’ Neighborhood.’)”. Decision, at pp. 2-3.

“Lame attempts at humor” from that whimsical jurist, Judge Wherry? Aw, Judge Posner, can’t ya take a joke?

Or maybe not, but you have to ask.

I thought I’d make it through a three-day weekend without my Tax Court fix, and I almost did, as I’m writing this just as my ship’s clock has struck five bells. But the urge is strong, so I had to hunt up the most likely order among Friday’s dross. And even though it’s a thrice-told tale, here’s the story of Harold W. Kuisel, Jr., Docket No. 19849-12, filed 8/30/13, as told by Judge Buch, the latest luminary on the Tax Court bench.

Hal starts off with what he calls “Petitioner’s Motion to Compel Respondent’s Compliance with Rules Governing Interrogatories and Requests for Production. Mr.Kuisel attached to his motion a copy of his request for production and interrogatories dated November 20, 2012, a copy of a Branerton letter from respondent dated December 20, 2012, and a letter from Mr. Kuisel to respondent dated February 6, 2013.”  Order, at p. 1.

You’ll remember the oft-quoted Branerton case, 61 T.C. 691 (1974), which states the well-worn “play nice and discover informally” rule. See my blogpost “Can Tax Court Be Habit-Forming?”, 12/20/11; I’ve cited Branerton at least eight (count ‘em, eight) times since then.

Well, Hal has bypassed Branerton, and that, as we know well, is a no-no. Judge Buch puts Hal right: “The documents petitioner attached to his motion reflect that Mr. Kuisel has made no attempts at informal discovery, such as simply requesting from respondent the documents that were used to create the substitute for return under section 6020(b) (to which he is entitled). However, the requirement of informal discovery continues and the document petitioner sent to respondent with interrogatories and requests for production of documents is formal, despite the title given to it by petitioner of ‘Informal Discovery Request’. An insistence on ‘compliance with his formal discovery requests in advance of any conference between the parties does not effectively present an opportunity for the “discussion, deliberation, and an interchange of ideas, thoughts, and opinions between the parties” that our Rules contemplate.’ Petitioner may continue to proceed in writing if he prefers, but that writing should not be in the form of making demands.” Order, at pp. 1-2. (Citations omitted).

Now Judge Buch set up a conference call with IRS and Hal, and it appears they’re playing nice and having a show-and-tell. They may even get around to the “discussion, deliberation, and an interchange of ideas, thoughts, and opinions between the parties that our Rules contemplate.”