Some of us who were born in the first half of the last century of the previous millennium may remember reading of “the Regiment in ‘ollow square”  as the Rogues’ March was played and the soon-to-be dishonorably discharged were marched in to be degraded. And which of us can forget José Ferrer’s impassioned cries in the 1958 film classic “I Accuse!”, as “France degrades an innocent man!”?

Well, today Tax Court’s Committee on Admissions, Ethics, and Discipline suspends or disbars nine attorneys, all of them on reciprocals from Federal or State Courts.

And only one of them, a many-times-decreed vexatious litigant, proclaims his innocence, and it falls flat.

So there but for the grace of you-know-Whom go any of us. And may none of my readers ever hear the Rogues’ March played for them or any of their colleagues.

If you’re interested, here the link to these sad tales.

Or rather, closing the book on Securitas Holdings, Inc. and Subsidiaries, Docket No. 21206-10, this iteration filed 7/2/13, Judge Buch confirming the conclusion of STJ Lew (What a Great Name!) Carluzzo back on 5/29/13 that Securitas, for itself, its holdings and its subsidiaries, waived its Section 7525 privilege, and must lay down all its communications with its tax adviser.

For the run-up, see my blogpost “Privilege Lost”, 5/29/13.

STJ Lew was in only to decide the evidentiary question: were the documents privileged per Section 7525, and, if so, had Securitas waived the privilege by spilling some of the beans to the Illinois State Department of Insurance? STJ Lew said yes, you’ll recall, the documents were privileged but the Illinois letter waived subject matter privilege, that is, every document dealing with the subject matter was unprivileged.

Judge Buch gets the reconsideration motion because he’s going to try the main case later on this month.

Judge Buch: “Subject matter waiver occurs when a party discloses privileged information to its advantage, such that fairness dictates that other privileged information concerning the same subject matter should fairly be considered to place the disclosed information in context.” Order, at p. 1, footnote 2.

Securitas, obviously less than convulsed with delight at STJ Lew’s stripping of the veil over their hush-hush discussions with said adviser, moves for reconsideration.

They lose.

Securitas argues that FRE Section 502 would keep the documents privileged. No it wouldn’t, says Judge Buch, and anyway Securitas never raised Section 502 before, and reconsideration is not the place to argue what you should have argued before.

Section 502 only protects disclosures made in state proceedings. But the letter that made the disclosure wasn’t part of any proceeding, that is, “‘the regular and orderly progression of a lawsuit, including all acts and events between the time of commencement and the entry of judgment’. Black’s Law Dictionary 1324 (9th ed. 2009).” Order, at p. 6, footnote 12. The letter was part of an application required by Illinois law whether or not there was a proceeding.

Centaur, the Securitas subsidiary in question, was in a rehabilitation proceeding, a species of insolvency proceeding, but the letter would have had to have been written, proceeding or no proceeding, if Centaur wanted to do whatever it was asking Illinois for permission to do.

Frankly, I don’t think much of this argument. There was a proceeding, akin to a bankruptcy, and it involved rehabilitating Centaur. And even though the Committee report on Section 502 says it wasn’t intended to change settled law on waiver of privilege, it does speak to the waiver in the State proceeding context, so I suppose it merely repeats the settled law. Whether the letter would have been required without a proceeding is beside the point, as if there hadn’t been a proceeding there never would have been a letter.

Finally, Securitas claims STJ Lew didn’t have authority to render a “decision” per Section 7443A)(c), as Section 7443A(b)(7) only gives him the right to hear, not decide, a case other than those specifically listed in Section 7443A(b)(1) through (6), not the catch-all provision (7). And this is a (b)(7) case.

Judge Buch: “Securitas correctly observes that section 7443A(c) limits the authority of a special trial judge to make a decision of the court in matters assigned under section 7443A(b)(7); however, in this instance, Special Trial Judge Carluzzo did not make a ‘decision’ as that term is used in section 7443A.

“In the Tax Court, ‘decision’ is a term of art. In a deficiency proceeding such as this, the ‘decision’ is the document that is entered showing the amount of the deficiency (if any) that the Court has determined. Special Trial Judge Carluzzo issued an interlocutory order, not a decision.” Order, p. 7.

And Securitas’ argument that Rule 183, which applies to cases “tried” by an STJ, wasn’t followed is irrelevant. There was no “trial”; there was a hearing on a motion.

Securitas loses. But if I were them, and if an appeal is possible, I’d appeal.

As always, I welcome comments from practitioners.

One of the most often requested (if not the most often requested) relief in a CDP is to contest the underlying tax liability. Taxpayers’ batting averages in Tax Court are far from encouraging in that respect.

Most often the response from Tax Court is “you didn’t petition the SNOD.” And where the amount sought to be collected comes straight from the taxpayer’s own return, the response is “you said it and you’re stuck with it.”

But here’s one where the taxpayer said it, and gets a chance to contest it. It’s George H. & Felomina F. Patton, Docket No. 16365-12L, filed 7/1/13, another Judge Laro off-the-bencher.

I am indebted to Judge Laro for printing the transcripts of the off-the-benchers. I know you can’t cite them and they aren’t precedent, but they offer a valuable insight into what Tax Court Judges think.

Anyway, George & Felomina filed their returns for the years at issue, but didn’t pay the taxes shown. IRS filed an NFTL, and George & Felomina asked for a CDP.

Here’s George’s story, in his own words, as told to Judge Laro: “I am 67 yrs. In August 2011, permanently disabled public safety officer since 1984 living on pension. paid medical insurance since retired not given credit for. Spouse paid withholding not given credit for. Government placed us in a hardship condition with its continuous trespass with water on our commercial property. it destroyed our tax record and made us unable to ascertain our deductions and correct amount of tax. File states abatement being considered. (emphasis added). “Decision, at p. 5.

George & Felomina claimed the NFTL should be withdrawn because “Responsible [sic] for correct amount of tax never ascertained.”  Decision, at p. 5.

George & Felomina got their CDP, but “(T)he settlement officer’s Case Activity Record, which would contain the settlement officer’s notes of what transpired during the CDP hearing, is not part of the record.” Decision, at p. 5. Of course, this is a motion  for summary judgment, so IRS claims George and Felomina never gave the SO the financial information requested until after the CDP, but when the SO tried to contact them with an installment offer, they didn’t respond.

Thus IRS’ position is the usual: they had their chance and they blew it, so abuse-of-discretion is the only thing to decide.

Judge Laro: “Contrary to respondent’s assertion, petitioners contested their underlying liabilities in their CDP request. The CDP request clearly stated that petitioners believed they were not given credits or deductions for certain tax withholdings and medical payments. The CDP request also claimed that petitioners’ tax records were destroyed by the ‘continuous trespass with water’, preventing petitioners from ascertaining their deductions and correct amount of tax. These statements together clearly show that petitioners believed the tax liabilities that they reported on their returns to be incorrect. Because ‘underlying tax liability’ referred to in section 6330 (c) (2) (B) encompasses self-assessed tax liability, petitioners were entitled to challenge the liabilities underlying respondent’s NFTL even though they had reported them on their own returns. Montgomery v. Commissioner, 122 T.C. 1, 7-8 (2004).

“Even when a taxpayer has made the underlying liability an issue in his CDP request, he is deemed to have abandoned the claim if he fails to pursue it in his CDP hearing. Schwartz v.  Commissioner, T.C. M:emo. 2008-117, 95 T.C.M. (CCH) 1427, 1430 n.9, aff’d, 348 Fed. Appx. 806 (3d. Cir., 2009). Here, respondent has failed to submit the Case Activity Record as an exhibit to his motion. This is problematic because the Case Activity Record would have allowed us to determine whether petitioners pursued the liability issue and presented evidence to support their claim during their CDP hearing. Viewing the facts in the light most favorable to petitioners as the nonmoving party here, we conclude petitioners properly raised the issue at their CDP hearing.”  Decision, at pp. 8-9.

Looks good for George & Felomina, right? Not quite.

They were late with their financial information and didn’t get back to the SO to discuss collection alternatives. So IRS wasn’t wrong when they refused to consider removing the NFTL or giving George & Felomina any collection alternatives. Those are off the table.

So, George & Felomina, it’s all about liability.

That’s the rule for determining whether there has been a constructive dividend from a C Corp to its shareholder, as stated by Judge Marvel in Terry J. Welle and Chrisse J. Welle, 140 T. C. 19, filed 6/27/13.

TJ and Chrisse built their dream house on the Detroit Lakes in Minnesota. They personally GC’d the job, but used TJ’s C Corp, TWC, a for-profit homebuilder, to funnel payments to subs and keep track of materials and labor on the job. TJ oversaw the job, picked the subs, and ran the show. He and Chrisse paid TWC for the actual cost of the TWC  services they used, including overhead, but did not pay the customary 6% to 7% mark-up TJ applied to TWC’s off-the-street customers.

IRS claimed the 6% was a dividend to TJ, the sole stockholder of TWC, as it was a forgone profit.

No, says Judge Marvel. While provision of services by a C Corp to its shareholder may be a constructive dividend under Section 317(a), “‘(T)he crucial concept in a finding that there is a constructive dividend is that the corporation has conferred a benefit on the shareholder in order to distribute available earnings and profits without expectation of repayment.’” 140 T. C. 19, at p. 5 (Citations omitted).

In other words, was whatever the shareholder got the equivalent of corporate earnings (not a return of capital or a loan repayment)? Is the deal a way to funnel corporate profits to the shareholder tax-free?

“The Code does not define the term ‘earnings and profits’. See sec. 316(a); Henry C. Beck Co. v. Commissioner, 52 T.C. 1, 6 (1969), aff’d per curiam, 433F.2d 309 (5th Cir. 1970). As we have previously observed, the calculation of earnings and profits is not easy or obvious. See, e.g., Anderson v. Commissioner,67 T.C. 522, 527 (1976), aff’d, 583 F.2d 953 (7th Cir. 1978); Juha v. Commissioner, T.C. Memo. 2012-68, 103 T.C.M. (CCH) 1338, 1341 (2012). For example, although section 1.312-6(a), Income Tax Regs., provides that a corporation must compute earnings and profits using the same method of accounting employed in computing taxable income, earnings and profits are not equivalent to taxable income.” 140 T. C. Memo. 19, at p. 7.

In other words, the question is what has the C Corp earned, whether taxable or not, being given to the shareholder, as opposed to what is the shareholder’s capital investment being returned.

There are cases that say when C Corp’s build houses for their shareholders without being repaid in full, there is a constructive dividend. But nowhere has Tax Court held that forgone profit has any place in the calculation.

Judge Marvel: “Respondent [IRS] does not explain how a corporation’s decision not to make a profit on services provided to a shareholder who fully reimburses the corporation for the cost of the services (including overhead) constitutes a distribution of property that reduces the corporation’s earnings and profits under section 316(a), nor does respondent cite any cases supporting such a position. Respondent argues that his position follows from the general rule that constructive dividends are ordinarily measured by the fair market value of the benefit conferred. It appears to us, however, that respondent’s argument skips an important analytical step required by section 316(a)–we must first find that there has been a distribution of property to the shareholder that reduces the corporation’s current or accumulated earnings and profits. A finding that a shareholder received a constructive dividend from a corporation is only appropriate where ‘corporate assets are diverted to or for the benefit of a shareholder’….” 140 T. C. 19, at p. 9. (Citations omitted).

The C Corp’s net worth must be impaired in some way. TJ paid in full for TWC’s services plus overhead. So, says Judge Marvel, “(W)e cannot see how TWC’s provision of services to Mr. Welle at cost resulted in the diversion of corporate assets or the distribution of its earnings and profits.” 140 T. C. 19, at p. 10.

TJ’s use of corporate assets was at best incidental; TWC got paid in full therefor, so TJ did not grow greater and TWC did not grow less.

TJ wins.

 Believe it or not, I have one who styles him/herself “Your Fan”. S/he addressed me today from cyberspace, drawing my attention to the ongoing saga of John Crimi and family.

You may remember my blogposts “Stick It”, 2/14/13, and “An Interest(ing) Question – Or Two”, 6/11/13, which set forth the sad tale of the Crimis and their charitable land donations.

Having emerged from 2013 T. C. Memo. 51, filed 2/24/13, with some of their deduction intact, the Crimis went on to fight over Section 6404(g) abatement of interest, the last hurdle before entering judgment and closing the cases.

But Judge Laro sent off the Crimis with a homework assignment in Docket No. 13252-09, filed 6/11/13: “They must file, within a week, ‘a Memorandum of Points and Authorities, not to exceed 10 pages, addressing (1) whether we have jurisdiction over petitioner’s claim under section 6404(g) and (2) in any event why petitioner should not be deemed to have waived any issues relating to interest.’” 6/11 Order, p. 2.

Now I thought that was the end. But My Fan, that industrious person, turned up a further order from Judge Laro, same Docket No., filed June 21, 2013, which interestingly (sorry, no pun intended) doesn’t show up on the Tax Court website Orders page for that date, or on the Crimi list of orders, but does show up on the Docket Search link.

So My Fan found the Stealth order. It doesn’t say anything new, but here it is, offered for completeness. Crimi’s counsel did their homework, timely filed their Memorandum of Points and Authorities, and Judge Laro kicks it to the curb.

“Petitioner argues that we have jurisdiction over the issue relating to suspension of interest under section 6404(g) because the petition seeks our review of respondent’s determinations made in the notice of deficiency, which petitioner believes includes a determination as to interest suspension under section 6404(g). In other words, the instant petition, as petitioner sees it, seeks our review of respondent’s determination as to tax deficiency under section 6212 as well as respondent’s purported determination as to interest suspension under 6404(g).” 6/11/13 Order, at p. 2.

But one SNOD can cover a multitude of taxpayer sins, and one separate sin may give rise to Tax Court jurisdiction, where another may not.

Judge Laro: “But for the Court to have jurisdiction over the Commissioner’s determinations, each of the determinations itself must be reviewable by this Court. Section 6404(g) requires the Commissioner to stop the accruing of interest if certain conditions are present. But we find no statutory grant of authority for the Court to review the Commissioner’s failure to do so.” 6/21 Order, at p. 2.

Here’s the chapter and verse: “Section 6404(h) confers on the Court jurisdiction to determine whether ‘the Secretary’s failure to abate interest under this section was an abuse of discretion.’ Sec.6404(h) (emphasis added). Section 6404(d) and (e) provides the Commissioner the discretion to abate interest if certain conditions are met; these are the only references to the Commissioner’s discretion to abate interest in section 6404. Surely, if Congress intended to grant the Court jurisdiction to review the Commissioner’s decision not to suspend the accruing of interest, which is not discretionary under section 6404(g), it would have clearly said so. See Goode v. Commissioner, T.C. Memo. 2006-48, 91 T.C.M. (CCH) 901, 905-906 (2006).” 6/21 Order, at pp. 2-3.

So, since the Crimis agreed to everything else, Judge Laro orders and decides the deficiency.

Thanks, Fan.

A very hot topic in the impenetrable thicket that is transfer pricing is the concept of the Advance Pricing Agreement. This is a deal akin to a PLR, where a taxpayer (and its parent and siblings) with international or transnational ramifications makes a deal with IRS or other taxing authorities, whereunder certain payments to offshore or near-shore affiliates (whose tax domiciles accord more favorable tax treatment to the recipient of the payments) will not be denied deductibility to the payor taxpayer by its tax domicile; likewise, income to such affiliates will not be aggregated or reallocated to the onshore parent or sibling.

Eaton Corporation and IRS made such deals. IRS claimed Eaton welshed on the deals, relying on certain Rev. Procs., and cancelled them retroactive to Day One, hitting Eaton with a Section 482 reallocation and  hefty deficiencies.

Eaton said that contract law determines whether there was a sufficiently substantial breach to allow IRS to call off the deals. IRS says the much lower barrier to cancellation is abuse of discretion, like a NOD on a CDP where taxpayer had a chance to contest the underlying deficiency. In other words, arbitrary, capricious or without sound basis in fact or law.

Clearly, this is a big deal. Abuse of discretion is a tough road for a taxpayer to walk; breach of contract is a lot easier by comparison. And this is a case of first impression.

And that’s all Judge Kroupa has to decide in Eaton Corporation, 140 T. C. 18, filed 6/25/13. And while it isn’t equal to what the Supremes did today with same-sex marriage, it’s certainly a big deal to Eaton and IRS.

Judge Kroupa: “We note that we decide the motions on a limited record. We will therefore decide only the legal standard to be used in reviewing the cancellations. We do not determine here whether respondent abused his discretion in canceling the APAs at issue.” 140 T. C. 18, at p. 3.

Now since the record is limited, Judge Kroupa can’t tell how Eaton is alleged to have welched, and how the two governing Rev. Procs. were breached, if in fact they were. The issue that APAs were supposed to resolve is what Eaton’s offshore subsidiaries were to be paid for certain circuit breakers they manufactured, using a comparable arms’-length standard.

Some quick background: “An APA is an agreement between the Commissioner and a taxpayer in which the parties set forth, in advance of controlled transactions, the best transfer pricing method within the meaning of section 482 and related regulations. Rev. Proc. 2004-40, sec. 2.04(1), 2004-2 C.B. at 51. Congress enacted section 482 to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. Sec. 482; sec. 1.482-1(a)(1), Income Tax Regs. The Commissioner developed the APA program to resolve highly factual transfer pricing issues in a principled, cooperative manner. Announcement 2012-13, 2012-16 I.R.B. 805, 806; Rev. Proc. 2006-9, sec. 2.02, 2006-1 C.B. 278, 279; Rev. Proc. 2004-40, sec. 2.04(1). A taxpayer voluntarily participates in the APA program in exchange for the Commissioner limiting his discretion under section 482 to make transfer pricing adjustments. See Rev. Proc. 2006-9, secs. 2.01, 2.04, 10.02, 2006-1 C.B. at 279, 289.” 140 T. C. 18, at p. 6.

Now exactly what can Tax Court decide? “Petitioner invoked this Court’s jurisdiction by filing a petition challenging respondent’s deficiency determinations that adjusted petitioner’s income. Respondent’s deficiency determinations resulted from the cancellations. Petitioner assumes that our deficiency jurisdiction includes jurisdiction to review the APAs at issue. Respondent emphasizes that the Court’s jurisdiction is to redetermine the deficiencies. He contends that we may review the cancellations under our deficiency jurisdiction for abuse of discretion because the cancellations were administrative determinations that are necessary to determine the merits of the deficiency determinations. We agree with respondent.” 140 T. C. 18, at p. 9.

Remember, Tax Court is a court of limited jurisdiction. If you learn nothing else from these essays of mine, remember that: too many high-priced lawyers, and a lot of cheap ones, have come seriously unglued by forgetting or ignoring that fact.

Judge Kroupa rams the lesson home: “The Tax Court is a court of limited jurisdiction and may exercise jurisdiction only to the extent authorized by Congress. See Kasper v. Commissioner, 137 T.C. 37, 40 (2011); Naftel v. Commissioner, 85 T.C. 527, 529- 530 (1985). The Tax Court is without authority to enlarge upon that statutory grant. See Phillips Petroleum Co. v. Commissioner, 92 T.C. 885, 888 (1989). We have jurisdiction to redetermine the correct amount of a deficiency. Sec. 6214(a). Our deficiency jurisdiction includes the authority to determine whether the Commissioner’s section 482 allocation was correct. That allocation must be sustained absent a showing of abuse of discretion. See, e.g., Veritas Software Corp. & Subs. v. Commissioner, 133 T.C. 297, 318 (2009); Sundstrand Corp. & Subs. v. Commissioner, 96 T.C. 226, 353 (1991). To succeed, therefore, petitioner must show that respondent’s section 482 allocations were arbitrary, capricious or without sound basis of law or fact. Veritas Software Corp. & Subs. v. Commissioner, 133 T.C. at 318.” 140 T. C. 18, at pp. 9-10.

Obviously, not wanting to pay the $368 million of deficiencies, plus interest, additions to tax and penalties, and then sue for a refund in US District Court or Court of Federal Claims, Eaton took the cheaper route.

“Here, the cancellations are administrative determinations necessary to determine the merits of the deficiency determinations. We will review the cancellations for abuse of discretion. The parties agree that respondent established the APA program pursuant to his authority to administer the Code and ‘prescribe all “needful rules and regulations”.’ 140 T. C. 18, at p. 11.

“We hold that our deficiency jurisdiction includes reviewing the cancellations because they are necessary to determine the merits of the deficiencies.   The relevant inquiry is whether respondent abided by the self- imposed limitations set forth in the applicable revenue procedures. We consequently will review respondent’s cancellations for abuse of discretion.” 140 T. C. 18, at p. 14. (Footnote omitted).

Here’s the footnote that sinks Eaton: “Petitioner’s assertion that general contract law governs the APAs at issue conflicts with the parties’ agreement that the legal effect and administration are governed by the applicable terms of the revenue procedures. Petitioner ignores the fact that the applicable revenue procedures reserve respondent’s discretion to administer the APAs at issue.” 140 T. C. 18, at p. 14, footnote 4.

And Eaton can’t shift the burden of proof to IRS; Eaton must show there is no sound basis in fact or law for IRS to abrogate the APAs, and good luck with that.

So beware, multinational, before entering into an APA; IRS has a powerful ace up its sleeve. If you wish to advance, prepare your line of retreat.

The late essayist and raconteur Harry Golden told the story of an immigrant who, after many years, finally attained US citizenship. Triumphantly forsaking his native tongue, he spoke only broken English thereafter, affecting to understand no other. Even when his wife would address him in their native tongue, he would turn to his US-born children and ask them “Vot did she set?” Thereupon his wife would bombard him with choice language.

Well, Judge Laro doesn’t get the choice language, but he does get the response to a bench opinion, in John Lee Southern & Debra Kay Southern, Docket No. 16222-12L, filed 6/24/13.

John Lee and DK petition from an Appeals denial of their CDP. IRS conceded the Section 6702(a) penalties for jurisdictional purposes only, and that was explained twice to John Lee and DK pre-trial.

Judge Laro: “The fact that respondent conceded the frivolous tax return penalties in the prior deficiency case on jurisdictional ground does not change our conclusion. The assessments and collection of section 6702 penalties are not subject to the deficiency procedures described in sections 6211 through 6216. Sec. 6703(b). Thus, it was improper for respondent to assert the penalties in his notice of deficiency under section 6212, and this Court had no jurisdiction under section 6213 to review their assessments. Moreover, the Court would not have jurisdiction to enforce any settlement agreement the parties might have reached over an issue if the original jurisdiction over that issue was lacking. United States v. Orr Const. Co., 560, 18 F.2d 765, 768-769 (7th Cir. 1977). Thus, as a matter of law, the stipulated decision we entered in the deficiency case could not have settled the issue relating to the section 6702 (a) frivolous return penalties.

“Moreover, petitioners have not provided any evidence disputing respondent’s claim that respondent’s counsel had explained to them in the pretrial conference that to dispute the penalties, petitioners had to pay the penalties first and then file a refund suit in the district court. Respondent had also stated substantially the same in his Letter 555-T provided to petitioners well before petitioners signed the stipulated decision. Thus, in all fairness, petitioners were on notice.” Bench opinion, at pp. 14-15.

So after Judge Laro announces victory for IRS, both John Lee and his counsel echo Harry Golden’s hero.

“MR. SOUTHERN: I really didn’t understand what you were getting at.

“THE COURT: I appreciate it, sir. You’ll have to get a copy of the opinion and then you can read it. A copy of the opinion will be made available to you.

“MR. CHMIELEWSKI: Okay. So, in other words, you’re going with what they said and then I have to appeal that decision.

“THE COURT: The Court has rendered an opinion and you may have a ground of appeal with respect to it. Thank you, sir.” Bench Opinion, at p. 16-17.

Vot did she set?

Advice to real estate operators who want to swap a leasehold for fee title in a Section 1031 like-kind exchange, a darling of the real estate operators. Thus Judge Marvel opines in VIP’S Industries Inc. & Subsidiaries, 2013 T. C. Memo. 157, filed 6/24/13.

VIP’s had a 21-year leasehold of some land where they built a motel. They tried to swap it for fee interests.

Quick refresher: “Generally, gain or loss realized from the sale or exchange of property is recognized. Sec. 1001(c). Section 1031 provides, however, that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind that is to be held either for productive use in a trade or business or for investment. Sec. 1031(a)(1). When money or unqualified property is received in an otherwise qualifying like-kind exchange, a taxpayer’s realized gain is recognized to the extent of the sum of such money and the fair market value of such unqualified property. Sec. 1031(b); sec. 1.1031(a)-1(a)(2), Income Tax Regs. The rationale for nonrecognition of gain or loss on the exchange of like-kind property is that the taxpayer’s economic situation after the exchange is fundamentally the same as it was before the transaction occurred. See Jordan Marsh Co. v. Commissioner, 269 F.2d 453, 455-456 (2d Cir. 1959), rev’g T.C. Memo. 1957-237; Koch v. Commissioner, 71 T.C. 54, 63-64 (1978). As a House report explained: ‘[I]f the taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit.’ H.R. Rept. No. 73-704 (1934), 1939-1 C.B. (Part 2) 554, 564.” 2013 T. C. Memo. 157, at pp. 7-8.

But like-kind means like kind, and while a thirty-year or more leasehold term is like-kind for fee title purposes per Reg. section 1.1031(a)-1(c), 21 years is too short. And State law has nothing to do with it.

Even though VIP’s owned the improvements, which had a far greater value than the raw land on which they stood, the lease said that the improvements belonged to the landlord on expiry or sooner termination.

No nonrecognition, and tax due. Go long for a leasehold 1031.

Not only are knowledge and sophistication dangerous, but when you know enough to get a money-back guarantee in case your tax maneuver craters, you can’t claim that there was a “non-negligible risk” that the deal would unwind. That’s Judge Gustafson’s less-than-obliging lesson for Lawrence G. Graev and Lorna Graev, in 140 T. C. 17, filed 6/24/13.

It’s another façade easement case. I’ve blogged so many of these that I won’t cite to them here.

Larry was canny; when he bought his historic New York property and was approached by easement-vendor National Architectural Trust (NAT), he “…sent an email to NAT explaining a concern that had arisen:

“‘My accountants have referred me to Notice 2004-41 * * * issued by the IRS on June 30, 2004, in which the IRS has indicated that it will, in ‘appropriate cases’, disallow charitable deductions to organizations that promote conservation easements and may impose penalties and excise taxes on the taxpayer. They have not advised me to abandon this idea, but they have advised me to be very cautious. What are your thoughts especially as it relates to the side letter, etc.’

“(The ‘side letter’ to which Mr. Graev referred was NAT’s comfort letter assuring that it would refund a contribution in the event that the favorable tax results anticipated from a contribution were not achieved.)” 140 T. C. 17, at p. 8.

Moreover, “(O)n his tax returns Mr. Graev listed his occupation as ‘attorney’, and we infer that he is an individual of above-average sophistication who, with the help of his accountants, was capable of identifying tax risks. We find that Mr. Graev did in fact identify non-negligible risks regarding the deductibility of facade easements, as evidenced by his … email and subsequent dealings with NAT.” 140 T. C. 17, at pp. 8-9.

NAT claimed it was SOP for them to give back whatever cash the servient tenant (that’s the owner of the property burdened by the easement, and not a bit player from “Fifty Shares of Grey”) gave them to enforce the easement, get the documentation recorded, etc., if IRS torpedoed the Section 170 façade easement deduction. Moreover, NAT would enter into a recordable revocation of the easement.

IRS claims this made the whole deal conditional, and therefore the thing of beauty was not a joy forever. There is a “non-negligible risk” that the easement would dissolve, the cash get repaid and everything revert to status quo ante.

In simplest terms, “26 C.F.R. section 1.170A-1(e) clarifies that principle: no deduction for a charitable contribution that is subject to a condition (regardless of what the condition might be) is allowable, unless on the date of the contribution the possibility that a charity’s interest in the contribution ‘would be defeated’ is ‘negligible’.” 140 T. C. 17, at p. 22. The charity must keep the donated property; any possibility of defeasance must be “negligible”.

Larry claims the condition argument is “new matter”, as to which IRS has burden of proof, but here there are no disputed facts, so burden of proof is irrelevant.

And Larry knew there was a real risk; he asked his accountants and he insisted upon the “side letter”, giving him his money back and his property free and clear of the easement, if IRS blew up the deal.

Larry claims his valuation of the easement was reasonable, and for this case that isn’t an issue, but there are other ways a façade easement deduction can be blown up other than valuation.

However that may be, “(T)he mere fact that he required the side letter is strong evidence that, at the time of Mr. Graev’s contribution, the risk that his corresponding deductions might be disallowed could not be (and was not) ‘ignored with reasonable safety in undertaking a serious business transaction.’ 885 Inv. Co. v. Commissioner, 95 T.C. at 161.

“Mr. Graev was not alone in his assessment of the risk of disallowance. NAT considered it ‘standard Trust policy’ to return a cash contribution to the extent a deduction therefor was disallowed by the IRS. In numerous instances NAT issued ‘comfort letters’ assuring donors of this policy. The very essence of a comfort letter implies a non-negligible risk; and the author uses the letter to induce the recipient to enter into a transaction.” 140 T. C. 17, at p. 34.

Larry’s arguments under New York Environmental Conservation Law and under Federal tax law avail him not. Whatever the law says, there remains a non-negligible possibility that IRS will blow up the deal and NAT will honor their commitments in the side letter.

Beware of the money-back guarantee.

The following appeared today on the Tax Court website, in red letters: “The U.S. Postal Service (USPS) has informed the Tax Court that due to a mail processing equipment failure at the facility which processes the Court’s First Class mail, First Class mail delivery to the Court has been temporarily suspended. USPS anticipates that delivery will resume at the earliest on Thursday, June 27. Until then, the USPS will deliver only Third Class, Express, and Priority mail. The Court will post advisories if circumstances change.”

No certified or registered either, guys; take out that  old dog-eared copy of Notice 2004-83, 2004-2 C.B. 1030, and send in those petitions.