Instead of agreeing to Schedule C concessions (see my blogpost “Stipulate, Don’t Capitulate”, 9/23/11) or failure to respond to a Rule 91 “facts deemed established” motion (see my blogpost “Stipulate, Don’t Capitulate – Part Deux”, 5/24/13), a Big Houston software outfit got hung up in a Section 482 transfer pricing settlement with IRS that winds up giving the hangee a $13 million deficiency.

Judge Kroupa, untangler of corporate tangles, gets this one: BMC Software Inc., 141 T. C. 5, filed 9/18/13.

BMC had a CFC, with which it developed software, and split up costs and sales territories. Then BMC killed the split and agreed to pay royalties to the CFC. Except IRS claimed the royalties weren’t arms’-length equivalents, and BMC capitulated, entering into a Section 7121 closing agreement, whereby BMC adjusted its gross income upwards to offset the claimed royalties to the extent not arms-length.

But that means the CFC’s income was less, so BMC had overpaid the CFC, and therefore BMC had to make secondary adjustments. BMC elected to treat the overpaid royalties as an account receivable from the CFC, rather than as a capital contribution to the CFC, per Rev. Proc. 99-32.

Judge Kroupa takes up the story: “To that end, petitioner and respondent entered into another closing agreement (accounts receivable closing agreement) that established for Federal income tax purposes interest-bearing accounts receivable from BSEH to petitioner. Respondent executed the accounts receivable closing agreement also…. The amounts of the accounts receivable corresponded to the amounts of the primary adjustments….

“The accounts receivable bore interest at the applicable Federal rate. The interest was deductible from [the CFC’s] taxable income and includible in petitioner’s taxable income.” 141 T. C. 5, at pp. 5-6.

The closing agreement provided that the CFC “will pay the account receivable, including interest thereon, by intercompany payment. Such payment will be free of the Federal income tax consequences of the secondary adjustments that would otherwise result from the primary adjustment; provided, the payment of the balance of the account, after taking into consideration any prepayment pursuant to section 4.02 of Rev. Proc. 99-32, is made within 90 days after execution of this closing agreement on behalf of the Commissioner.” 141 T. C. 5, at p. 6.

The CFC made the payment of the balance and interest on schedule.

Some years later, BMC had a mega-wad of cash offshore, parked in its CFC, so BMC wanted to take advantage of the Section 965 one-time tax-free dividend from a CFC. So BMC hauled back $721 million, and claimed it was all tax-free.

Except IRS claimed that the accounts receivable from the royalty settlement was related-party indebtedness, which reduces the tax-exempt part of the dividend from the CFC, thus the $13 million deficiency.

BMC claims Section 965(b)(3) doesn’t apply, as this deal isn’t an abusive transaction; in other words, that BMC didn’t fund the dividend from CFC. The royalty settlement took place years before, but within the timeframe when the accounts receivable would be considered related-party indebtedness.

But Judge Kroupa can’t find explicit language in Section 965(b)(3) limiting its scope to abusive deals. True, the statute gives Treasury power to enact regulations to prevent abuse, but that’s supplementary, not limiting.

Next, BMC claims the receivables weren’t debt. But IRS goes to Hank Black, law dictionarian. “Account receivable is defined as ‘[a]n account reflecting a balance owed by the debtor.’ Black’s Law Dictionary 18. Petitioner observed those requirements and included only the interest payments as income.” 141 T. C. 5, at p. 14. That’s debt.

Now for the magic language in the settlement agreement that the receivables deal “will be free of the Federal income tax consequences of the secondary adjustments that would otherwise result from the primary adjustment”.

Judge Kroupa: “Petitioner contends that the accounts receivable closing agreement precludes any further Federal income tax consequences resulting from the repayment. The accounts receivable therefore would be excluded when determining the amount of the dividend received deduction. Respondent contends that the accounts receivable closing agreement provision allows petitioner to substitute the tax consequences of the debt secondary adjustment for those of the deemed capital contribution secondary adjustments. Put another way, the accounts receivable would be established for all Federal income tax purposes with petitioner avoiding the consequences of the repayment for a deemed capital contribution. We agree with respondent.” 141 T. C. 5, at p. 16.

In other words, what BMC got was relief from capital contribution consequences and the chance to get its overpaid royalty money back tax-free, not a perpetual tax exemption. If BMC didn’t take the Rev. Proc. 99-32 route, it would have had to pay tax on the full amount it got back from the CFC when the royalty deal was blown up. It was the payback that was exempt from Federal tax consequences. And exempt because it was repayment of debt incurred during the period prohibited under Section 965(b)(3).

But it was still debt, and therefore not shielded by the tax-free one-time dividend.

Takeaway- The Law of Unintended Consequences applies to stipulations and settlements.

No, not the one-hit wonder The Hombres campaigned in 1967. It’s the general view manifested in Tax Court when taxpayers request protective order, or make motions in limine, or motions to strike pleadings.

The subject was raised by Mr. Patrick Temple-West, the enterprising reporter for Reuters, in an e-mail to me today, asking if I had statistics on won-lost, as these tend to show up in big-ticket cases. See, for example, my blogpost “Privilege Lost”, 5/29/13.

I told Mr. Temple-West I had no statistics, but it was my firm impression that taxpayers rarely get protective orders; see my blogpost “Guy On Board”, 9/13/12, the story of Diamond Packaging. But when the IRS wants a protective order, they generally (love that word!) get one; see my blogpost “Ask Me No Questions”, 6/7/12. However, bless his contrarian heart, the Judge Who Writes Like A Human Being, a/k/a The Great Dissenter, Judge Mark V. Holmes, splits the melon in my blogpost “Paraphrasing Mark Twain”, 12/12/12.

And now comes The Judge With A Heart, STJ Armen, with further proof of the foregoing, in Estate of John H. Kelleher, Deceased, Madeline Kelleher, Administrator, Docket No. 6863-13, a designated hitter filed 9/17/13.

Maddy wants IRS’ answer to her petition redacted by STJ Armen to remove “…the disputed paragraphs [which] refer to a criminal case against John H. Kelleher that was dismissed on account of his intervening death and therefore did not result in a final judgment of conviction.” Order, at p. 1.

However, IRS’ response to Maddy’s request “…is well founded and thorough, incorporating legal precedent in support of respondent’s approach….”, STJ Armen gives us one citation, Nan R. Williams, 1991 T. C. Memo, 521, filed 10/21/91.

Nan, unlike the late John H., pled guilty. John H. did not live to confront his accusers. That cuts no ice with STJ Armen. “Motions to strike are analyzed under Rule 52 of the Tax Court Rules of Practice and Procedure. Rule 52 provides that this Court, upon a timely motion of a party or on its own initiative, may strike from any pleading any insufficient claim or defense or any redundant, immaterial, impertinent, frivolous, or scandalous matter. Rule 52 was derived from Rule 12(f) of the Federal Rules of Civil Procedure.” Order, at pp. 1-2. (Citations omitted).

And Federal Judges don’t like to strike stuff in pleadings. “In general, motions to strike pleadings have not been favored by the Federal courts. A matter will not be stricken from a pleading unless it is clear that it can have no possible bearing upon the subject matter of the litigation.” Order, at p. 2 (Citations omitted).

So Maddy, answer the paragraphs you wanted stricken, because they won’t be.

Whether someone is living or dead, the rule in Tax Court is “Let It All Hang Out.”

 Three blogposts in one day. To complete the hat trick, it’s an old, familiar face, Joyce A. Linzy, 2013 T. C. Memo. 219, filed 9/16/13.

Remember Joyce? Not sure? See my blogpost “The Preparer – Unprepared”, 11/8/11, Joyce’s last appearance in Tax Court.

It’s the usual unsubstantiated deductions story, on which I won’t waste much time.

The only useful tidbit is Judge Kerrigan’s comment on gambling losses. Joyce claims she has them to offset her winnings (reported on W-2Gs, of course), but didn’t take the losses on her return.

Judge Kerrigan: “Taxpayers who are not in the trade or business of gambling and who choose to calculate their taxable income using itemized deductions in lieu of the standard deduction may deduct gambling losses under certain circumstances. Section 165(d) provides that ‘[l]osses from wagering transactions shall be allowed only to the extent of the gains from such transactions’.” 2013 T. C. Memo. 219, at p. 11.

OK, but (and there’s always a “but”): “In the case of gambling winnings and losses taxpayers can substantiate their income and deductions by maintaining a contemporaneous log, see Schooler v. Commissioner, 68 T.C. 867, 871 (1977), or by consistently using a player’s card which monitors gambling activity, see Lutz v. Commissioner, T.C. Memo. 2002-89. Many taxpayers do not keep a detailed record of their wagering winnings and losses, but we do not treat taxpayers who claim to have sustained wagering losses more favorably than other taxpayers by allowing a deduction for wagering losses when the evidence is inadequate. Schooler v. Commissioner, 68 T.C. at 871.” 2013 T. C. Memo. 219, at pp. 11-12.

Joyce has withdrawal slips from ATMs at casinos, but that’s not good enough. Unlike Fortunato Gonzalez and Maria C. Gonzalez, as to whose gambling exploits see my blogpost “The Gamblers”, 8/6/12, she doesn’t tie the withdrawals in with the gambling activities, and unlike Fortunato and Maria C., gambling’s not Joyce’s major source of income.

A pocket notebook, even the paper kind, is a gambler’s friend.

The Few (no not the RAF, the long-suffering readers of this blog) will remember, perhaps, the redoubtable Freddie. If you’ve mercifully forgotten this gem of the Tax Court Bar, see by blogposts “How Not To Do It”, 11/21/12, and “The Business As ATM”, 6/20/13.

This is not another tale of Freddie’s missteps. Unhappily, Freddie has a colleague who is living up (or rather, down) to Freddie’s standards.

Here’s the story of Ella Wallace, as told by Judge Cohen in 2013 T. C. Memo. 218, filed 9/16/13.

Ella wants Section 6015(f) relief. Husband Ronald was running a family business called American Haulers, and the Wallaces also owned an oil field servicing outfit, but Ronald fell ill (and was at death’s door, according to Ella’s attorney, whom we shall call Yeff). Ronald’s successor, Wilbanks, ran the haulers into the ground before dying “his own se’f”, as they say in East Texas.

There’s a little matter of $7800 in tax due for the year at issue, per the joint return Ella and Ronald filed. Ronald and Ella were still married during this time.

IRS assesses tax and interest. Ella timely filed Form 8857, but “(T)he information petitioner submitted through her counsel to the Appeals Office in support of her request for relief consisted primarily of information concerning Wallace’s health. The only submitted financial information reported that American Haulers was out of business; no personal financial information concerning income, assets, expenses, or liabilities was submitted.” 2013 T. C. Memo. 218, at p. 3. A wee bit sketchy for a Section 6015(f) case, whether old rules or new rules apply.

Nevertheless, IRS reviews under the new rules, Notice 2012-8, 2012-4 IRB 309. For further details, see my blogpost “Innocence is Bliss”, 1/6/12. The spectre of Sriram is off the table at IRS, and Judge Cohen doesn’t pick up on it here.

This is probably because she finds 2012-8 irrelevant. “(Although streamlined procedures have been proposed by Notice 2012-8, supra, economic hardship and knowledge are still factors to be considered under the proposal. Reconsideration of petitioner’s request during the pendency of this case is immaterial to the result). 2013 T. C. Memo. 218, at p. 6.

“Petitioner did not appear at trial, and the parties submitted the case fully stipulated under Rule 122. Her counsel represented that Wallace’s continuing illness prevented petitioner’s appearance. Respondent did not object to an affidavit signed by petitioner, and it was received in evidence. That affidavit, however, addressed only Wallace’s [Ronald’s] poor health, Wilbanks’  mismanagement of American Haulers, and Wilbanks’ death. Petitioner acknowledges that ‘our personal income during this time was from Wallace Tool[s].’[The oil well servicer] The affidavit did not address the material issues, to wit, whether petitioner knew or should have known that the tax reported on the 2007 return would not be paid, whether she would suffer financial hardship if required to pay it, and whether it would be inequitable to hold her liable for the unpaid balance.” 2013 T. C. Memo. 218, at pp. 5-6.

The result, of course, is that Ella doesn’t get innocent spouse treatment.

Now it’s true that a sloppy record alone is no reason why I should call attention to Yeff’s performance. After all, greater attorneys than he (inter alia, as the expensive lawyers say, F. Lee Bailey; see my blogposts “Service Trumps Sickness”, 4/2/12, and “A Victim Of His Own Success”, 4/4/12) have come to grief in Tax Court.

But Yeff, like Freddie, isn’t a first-time neophyte. “The Court takes judicial notice that counsel has appeared of record in numerous cases in this Court.” See Ella Wallace, Docket No. 20522-10, filed 9/5/13, at  p. 2.

Judge Cohen anent Yeff’s performance; for starters: “On August 9, 2013, petitioner’s Counsel was directed to show cause why he should not be subject to sanction for failure to comply with the Court’s Orders and Rules. On August 22, 2013, the Court received a document titled ‘Motion to Set Aside the Judgment and to Allow for a Late Filing of a Responsive Brief Tax Court Rule 162 and Federal Rule of Civil Procedure 60.’ That document could not be filed as titled because there was no judgment in this case. An opinion, much less a decision, had not been filed. The cited rules have no application in this situation. No reply brief was attached. The Clerk of the Court, therefore, was instructed to file the document as a Response to Order to Show Cause, as the content indicated it was intended. The content of that response, however, misstates the record, misstates the authorities, and cites irrelevant case law.” Ella Wallace, Docket No. 20522-10, filed 9/5/13, at p. 1.

But wait, there’s more: “A practitioner before this Court is required to carry out his or her practice in accordance with the letter and spirit of the Model Rules of Professional Conduct of the American Bar Association. Rule 201(a), Tax Court Rules of Practice and Procedure. Tax Court Rule 202(a)(3) specifically identifies as a ground for discipline any conduct that violates the letter and spirit of the Model Rules. For example, Model Rule 1.1 requires a lawyer to provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation. Model Rule 1.3 requires a lawyer to act with reasonable diligence and promptness in representing a client. Model Rule 3.4(c) prohibits a lawyer from knowingly disobeying court rules and orders. Counsel’s conduct in this case seems to have been deficient on these and possibly other grounds.” Order, at p. 2.

I know that there but for the grace of you-know-Whom go any of us. And we’ve all blown cases, and sometimes blown ’em big-time. But isn’t it time for a competency test for Tax Court?

Whoever was advising the taxpayer in Creditron Financial Corporation, 2013 T. C. Memo. 217, filed 9/16/13 (and get those corporate returns in today, guys! Don’t waste time reading this blogpost), wasn’t down at National Harbor, MD last month, because the IRS’ presenters there made it very clear that the Collections Appeal Program is not the same as Collections Due Process. By a long way.

I’ll spare you the lengthy saga of Creditron and its unpaid 941s and FUTA. Creditron filed the returns but didn’t pay all the tax due, so IRS assessed and tacked on interest and additions. Creditron petitioned late from a CDP denial, so no Tax Court. Then Creditron asked for and got an equivalent hearing (again no trip to Tax Court from denial of taxpayer’s appeal).

But Creditron did file Form 9423 (more than once), looking for a Collections Appeal Program hearing. Which Creditron got, but lost again, as they were consistently noncompliant with paying their withholding taxes.

Of course, Judge Chiechi tosses Creditron’s petition on jurisdictional grounds.

As to the CAP vs CDP: “The Collection Appeals Program provides an administrative appeal for ‘certain collection actions’ and the rejection and termination of installment agreements. IRM pt. 8.24.1.1.1(1)-(3) (May 27, 2004). The IRM points out the distinction between a CAP Appeals Office hearing and an Appeals Office hearing, see, e.g., IRM pt. 5.1.9.4(1) (Jan. 1, 2007), and indicates that ‘[t]he taxpayer has the right to go to court on Appeals’ determinations under CDP but not under CAP, see IRM pt. 8.24.1.1.1(5).14.'” 2013 T. C. Memo. 217, at p. 28 (Footnote omitted, but I’m getting to it).

The omitted footnote: “Consistent with IRM pt. 8.24.1.1.1(5) (May 27, 2004), the instructions for Form 9423 informed the taxpayer that ‘[o]nce the Appeals Officer makes a decision on your case, that decision is binding on both you and the IRS. This means that both you and the IRS are required to accept the decision and live up to its terms.’” 2013 T. C. Memo. 217, at p. 28, footnote 14.

That means binding arbitration, guys. No review by Tax Court or anyone else. Take a Collections Appeal at your peril.

A designated hitter from Special Trial Judge Lew (The Right Spelling) Carluzzo teaches Pierre R. Levy, tax matterer, that no FPAA can ever be small enough to merit Section 7463 small-claimer treatment.

The case is Go Apparel, LLC, Pierre R. Levy, Tax Matters Partner, Docket No. 3519-13S, filed 9/13/13, but it won’t be “S” once STJ Lew gets through with it.

Pierre petitions from what he calls a deficiency, except it isn’t, and asks for the case to be treated as a small claimer, which it also isn’t.

There’s no SNOD, rather there’s a FPAA. Now that sets up a Section 6226(a) petition. But Section 7463(a), the small-claimer statute, speaks only of a “redetermination of a deficiency”, and this isn’t a deficiency (although it may wind up so for the partners). At least, not yet.

So IRS moved to drop the letter “S” from the docket. STJ Lew says that’s moot (although he might have granted the motion), but orders the “S” dropped anyway, and strikes the case from the small-claims calendar, continuing it generally (that is, adjourning it until it can be tried in a proper place).

A FPAA is never small.

Not much out of Tax Court today, 9/12/13, but nice to see my blogpost “Bowling For Dollars”, 9/10/13,  got picked up by the Texas Society of Certified Public Accountants on their 2014 Tax blog.

But here’s a tidbit for my fans.

Turns out Judge Laro isn’t the only Tax Court Judge facing intelligibility questions. See my blogpost “Vot Did She Set?”, 6/25/13. Judge Buch has a somewhat different problem in the same vein, when he confronts Securitas Holdings and Subsidiaries, Docket No. 20216-10, filed 9/12/13.

You’ll remember that Securitas was the insurance company with Section 501(c)15 problems; if not, see my blogposts “Privilege Lost”, 5/29/13, and “Closing the Buch”, 7/2/13.

Well, following the document joust, Securitas and IRS had a trial. But the results were less than satisfactory.

Judge Buch: “On September 11, 2013, the Court held a conference call with the parties regarding errors in the transcript and multiple portions of testimony that are described in the transcript as ‘inaudible’.” Order, at p. 1.

So it is “ORDERED that Capital Reporting Company shall again listen to the tapes of the proceeding held in Washington, DC on July 23, 2013, to verify portions already transcribed and correct portions labeled ‘inaudible’ and shall provide a corrected transcript, along with a Certificate of Transcriber and Proofreader, to the Court and to counsel for each party on or before September 27, 2013.” Order, at p. 1.

Vot did she set?

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.