The Right Regulation

Paraphrasing a well-known principle current in the select and elegant seminary for young ladies, among whose alumnæ and attendees are the daughter of Donald Trump and the daughters of Lewis C. Taishoff, before true income comes the Section 482 Regulations.

But Judge Laro leaves us wanting more, in Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al., 146 T. C. 5, filed 2/29/16.

There’s a bushelbasketful of et als, as Judge Laro leads us through a chain that reads like a cruise line brochure. “Guidant Corp.’s first-, second-, and third-tier foreign subsidiaries included two Netherlands corporations, Guidant BV (renamed Guidant Group BV in 2003) and Guidant Puerto Rico BV, and one Luxembourg corporation, Guidant Luxembourg SARL. Guidant Puerto Rico BV and Guidant Luxembourg SARL were subsidiaries of Guidant BV.” 146 T. C. 5, at p. 8. Oh, of course there were some Irish corporations in on the tackle.

And Guidant, health equipment manufacturer, swapped tangible and intangible personal property around, and provided services, with abandon, reporting all on a consolidated return.

IRS descends with Section 482 and a transfer pricing bouillabaisse featuring $3.5 billion in deficiencies.

 “Respondent considered whether the transfer of intangible property, the sale of components and finished goods, and the provision of services with respect to certain products (collectively, transactions at issue) were made at arm’s length.” 146 T. C. 5, at p. 15.

Holy Altera, Batman, what else is new?

But we have a consolidated return, right? So do we start with STI or CTI?

Well, usually Separate Taxable Income and work from the bottom up. But IRS claims the info Guidant supplied wasn’t sufficient to do that, so IRS went with Consolidated Taxable Income and re-routed the numbers as aforesaid.

Guidant wants summary J, and I like the tactic, as I’ve said before.

Not today. Guidant claims not doing separate STIs for each entity is an abuse of discretion as a matter of law.

“Nothing in the text of section 482 requires respondent to make member-specific adjustments to reflect income clearly. Petitioners do not dispute that the statute does not specifically set forth a member-specific adjustment requirement but argue that such a requirement is found in the regulations interpreting the statute, specifically, in section 1.482-1(f)(1)(iv), Income Tax Regs.” 146 T. C. 5, at pp. 25-26.

 But all the Reg does is require IRS to determine both STI and CTI consistently with consolidated principles. “The plain language of the regulation thus clearly mandates that both CTI and STI be determined, but the regulation does not specifically require that the Commissioner determine STI contemporaneously with his making of a section 482 adjustment.” 146 T. C. 5, at p. 27.

Judge Laro waxes eloquent. “Four score and three years ago, the U.S. Supreme Court stated in the setting of two corporations desiring to file a consolidated return that ‘[t]he requirement of consolidated returns was “based upon the principle of levying the tax according to the true net income and invested capital of a single business enterprise, even though the business is operated through more than one corporation.’” Atl. City Elec. Co. v. Commissioner, 288 U.S. 152, 154 (1933) (quoting Regs. 45, art. 631). The Supreme Court’s statement parallels a statement that the Senate Finance Committee memorialized in its report on (and issued contemporaneously with) the birth of the consolidated return regime. See S. Rept. No. 65-617, (1918), 1939-1 C.B. (Part 2) 123 (stating that the consolidated return regime was adopted with an understanding that the ‘principle of taxing as a business unit what in reality is a business unit is sound and equitable and convenient both to the taxpayer and to the Government’). The legislative history and the Supreme Court statement reveal that the primary principle underlying the consolidated return regime is a taxing of the true net income of the consolidated group as a whole.” 146 T. C. 5, at pp. 28-29.

Here’s the takeaway.

 “Consistent with the IRS practice on this matter, section 1.482-1(f)(1)(iv), Income Tax Regs., does not preclude the Commissioner from deferring making the ‘true’ STI determination for each member until the time when such a determination is actually required. Of course when that time comes, e.g., when a determination of STI is needed to process setoffs under section 482, see, e.g., sec. 1.482-1(g)(4)(i), Income Tax Regs., or to process separate return limitation year items such as net operating losses, see sec. 1.1502-21, Income Tax Regs., the regulation requires that a member’s STI must be determined consistently with the goal of taxing the consolidated group on its true CTI.” 146 T. C. 5, at p. 31.

Here’s the excuse. “Petitioners allege that they maintained all the necessary information and records to make the STI determinations, but it would be too costly or otherwise difficult for respondent to extract that information at the time of the audit from petitioners’ accounting databases. Whether respondent’s decision to delay the STI computations constitutes abuse of discretion under these circumstances is thus still in dispute and remains to be determined on the full record of the case as developed at trial.” 146 T. C. 5, at pp. 33-34.

Note the Court didn’t decide IRS wasn’t arbitrary, capricious or unreasonable; nor did the Court find any facts. All the Court found was that IRS wasn’t arbitrary, etc., as a matter of law.

Guidant claims IRS mixed services with tangible property with intangible property, and that goes a bridge too far despite the Regulations’ broad sweep.

No, again that’s a question of fact.

Let’s have a trial.

Wanna bet this settles?

Before I get down to my serious work, I must express my condolences to Judge L. Paige Marvel, elected to succeed Ch J Michael B (“Iron Mike”) Thornton as Ch J for two years, effective 6/1/16.

She deserves better than ploughing through non-pros dismissals, “pay the sixty bucks” injunctions, and all that jazz.

I am, however, looking for an appropriate cognomen for Her Honor in her new role. I had thought of “Captain”, but it seemed trite. I will accept suggestions for my review through and including May 1, but no prize for acceptance, and contestants surrender all rights to submissions. Moreover, my decision is in all and every respects final, and no correspondence will be entered into.

Now Go Away

Ch J Michael B. (“Iron Mike”) Thornton is not dismissive toward X, Docket No. 29460-15, filed 2/26/16, but Congress certainly was. Name removed at petitioner’s request.

IRS gave X a CP504. This is a notice that IRS has grabbed X’s State tax refund, but accords no Section 6330 rights to a CDP, “except that the taxpayer shall be given the opportunity for the hearing described in this section within a reasonable period of time after the levy.” Section 6330(f).

X has been in what seems to be a running fight with IRS, and demands the sixty-buck-ticket-to-justice. IRS moves to toss X’s petition. No NOD, no jurisdiction.

X objects. “The brief document stated in its entirety: “I am writing to object to the IRS’ motion to dismiss this case. I would like the opportunity to present my case to the United States Tax Court. Dear United States Tax Court, thank you for your time and assistance on this matter.” No reference was made to any further notices that might support an exercise of jurisdiction.” Order, at p. 2.

In the words of a much more highly exalted Personage, “’Grant me justice against my adversary.’”

Alas, Tax Court cannot.

“The earlier petition had detailed difficult personal and financial circumstances and the role therein played by IRS activities. It also recounted repeated, and frequently unsuccessful, attempts to communicate with the IRS, noting that the IRS had been unhelpful and had further compounded problems by refusing an offer in compromise. Thus, the record at this juncture suggests that petitioner sought the assistance of the Court after having become frustrated with attempts to work administratively with the IRS but that the petition here was not based upon or instigated by a specific IRS notice expressly providing petitioner with the right to contest a particular IRS determination in this Court. Unfortunately, suffice it to say a parsing of the record reveals that, while it is clear petitioner has been engaged in ongoing efforts and correspondence to deal with the IRS, respondent’s jurisdictional allegations stand unrebutted. Critically, no communication reflected in the record of this case constitutes, or can substitute for, a notice of deficiency issued pursuant to section 6212, I.R.C., or a notice of determination issued pursuant to section 6320 and/or 6330, I.R.C. Only a narrow class of specified determinations by the IRS can open the door to the Tax Court. An IRS Notice CP504, the sole notice offered by petitioner to date, does not fall into that class.” Order, at pp. 2-3.

And X’s stand-alone OIC gives no jurisdiction either, unlike one made at Appeals in a CDP.

“Therefore, while the Court is sympathetic to petitioner’s situation and holds great respect for his military service, the Court on the present record lacks jurisdiction in this case to review any action (or inaction) by respondent in regard to 2014. Congress has granted the Tax Court no authority to afford any remedy in the circumstances evidenced by this proceeding, regardless of the merits of petitioner’s complaints.” Order, at p. 3.

What about that Section 6330 hearing “within a reasonable period of time after the levy?” Who enforces that?

Today’s Tax Court tale gives us a replay of an old story: a well-established, profitable business married via a common controlling shareholder to a struggling start-up.

Kay Carpets, Inc., 2016 T. C. Memo 30, filed 2/25/16 is the moneyed spouse, as the family law types say, and Clean Hands Co, Inc., the struggling start-up. Ray Johnson and wife Geraldine wholly own Kay, and Ray solus owns Clean Hands.

Ray is inventive. Aware that food service establishments must monitor employee handwashing to comply with health codes, Ray starts with a RFID badge system that dispenses soap and monitors uses. That doesn’t go over, so he tries a voice-operated system.

The old joke “I don’t know about the others, but I use the spoon” clearly doesn’t work.

Ray hires a six-figure computer geek with an impressive resumé, first to work on the RFID with Kay, and then to work on the voice at Clean Hands.

The geek also did some work on Kay’s own computer systems.

Of course, no way could Clean Hands come up with the geek’s heavy-duty wage packet. So Kay paid Clean Hands for work on its own systems, and also for work on the voice system.

Ray owned the patent on the geek’s work (work for hire, y’know). And as sole shareholder of Clean Hands, if the device took off, Ray was the lead beneficiary.

“Mr. Johnson did not present any credible evidence that Key Carpets owned the voice-activated hand washing monitoring system. His testimony that Key Carpets owned the voice-activated hand washing monitoring system was vague, unclear, and not credible. Mr. Johnson’s testimony contradicts his statements that he owned the patent on the voice-activated hand washing monitoring system. Additionally, the parties stipulated that Mr. Johnson was the sole owner of Clean Hands. Although Key Carpets had an ownership interest in the initial RFID badge-activated hand washing system, Key Carpets had no interest in the new voice-activated system that the computer technician developed as a Clean Hands employee. The Court therefore finds that Key Carpets did not own the voice-activated hand washing monitoring system.” 2016 T. C. Memo. 30, at pp. 12-13.

Key Carpets got no benefit from any of the geek’s work on the voice system. While IRS only wants to allow Key Carpets a minuscule part of the geek’s pay as ordinary and necessary, Judge Paris goes with the geek’s 15% estimate.

The rest is a constructive distribution to Ray. It’s not a dividend unless Kay Carpets has earnings and profits, those undefined and elusive little devils, and while IRS and Ray agree on some numbers, the rest depends upon Judge Paris’ opinion.

Judge Paris gives us a quick review.

“A dividend is any distribution a corporation makes to its shareholders out of earnings and profits. Sec. 316(a). The distribution is first made out of the earnings and profits for the current taxable year. See id. When current earnings and profits are insufficient, the distribution is made out of accumulated earnings and profits. See id. When a corporation does not have sufficient earnings and profits for the entire distribution to constitute a dividend, the remaining amount is not a dividend but reduces the adjusted basis of the shareholder’s stock in the corporation. Sec. 301(c)(2). The amount of the distribution that is not a dividend or does not reduce basis is generally treated as gain from the sale or exchange of property. Sec. 301(c)(3); see also sec. 1001.” 2016 T. C. Memo. 30, at p. 19.

And the payments weren’t a loan. No paperwork.

Now while Ray used his accountant to prepare his and the corporations’ returns, that doesn’t help with the chop.

“Petitioners argue that they acted with reasonable cause and in good faith because petitioners provided all records to their accountant and had a reasonable basis for the business deductions. However, petitioners did not act in good faith, because their positions run contrary to established law. Mr. Johnson testified that he provided all records to his accountant on whom he relied to prepare his corporate and individual returns, but petitioners did not offer any evidence about whether they sought advice from their accountant about the deductions or whether the Key Carpets payments to Clean Hands constituted constructive distributions. Because petitioners’ positions run contrary to established law and petitioners have not shown that they reasonably relied on their accountant to do anything more than prepare tax returns, petitioners have not met their burden of proving that they acted in good faith with reasonable cause, and the Court sustains the section 6662(a) accuracy-related penalty. 2016 T. C. Memo. 30, at pp. 26-27. (Footnote omitted, but read it; because there’s substantial understatement, negligence doesn’t matter).

The Magic Letters

Raymond S. McGaugh, 2016 T. C. Memo. 28, filed 2/24/16, wanted to buy some stock for his IRA. Although the purchase wasn’t a prohibited transaction, the trustee refused to buy. So Ray told the trustee to wire the purchase price directly to the corporation; and Ray told the corporation to issue the stock certificate thus: “Raymond McGaugh IRA FBO Raymond McGaugh.”

FBO = For Benefit Of.

The stock certificate is apparently MIA; the trustee claims they only got the stock certificate in the following tax year (which isn’t before the Court), and tried to mail the stock certificate to Ray twice. It bounced back both times. But the trustee claims Ray got the stock certificate the next year.

Ray says he never got the stock certificate, the trustee issued Ray a 1099-R for the purchase price, and Ray petitions.

“No cash, check, or wire transfer ever passed through Mr. McGaugh’s hands, and he was therefore not a literal ‘payee or distributee’ of any amount.” 2016 T. C. Memo. 28, at p. 9.

Even if the trustee wired the purchase price at Ray’s direction, so what?

“The owner of an IRA is entitled to direct the investment of the funds without forfeiting the tax benefits of an IRA. Even acknowledging that Mr. McGaugh pulled all the strings, it remains true that the funds the IRA released went straight to the investment and resulted in the stock shares’ being issued straight to the IRA.” 2016 T. C. Memo. 28, at p. 9.

I’m not sure what “stock shares” are, but let that pass.

But even if Ray got the money constructively, he was a mere conduit. He had no claim of right to the money. The delay in issuing and delivering the stock certificate was not on Ray’s watch. And Judge Gustafson isn’t going to discuss what effect the delivery in the next year has, as the next year is not before the Court.

Ray wins.

And the winning counsel is one who was somewhat rudely handled in the past. See my blogposts “You Have to Fulfill The Requirements”, 8/20/13, and “Blowing the Joint”, 6/24/14.

Eric Onyango wins one. Good job, Eric.

Not so fortunate is Mark Vandenbosch and Julie Vandenbosch, 2016 T. C. Memo. 29, filed 2/24/16.

Mark actually got his hands on the cash and ran it through several bank accounts, to all of which he had unfettered access.

But Mark relied on his CPA, with whom he had a twenty-year relationship, so he avoids the substantial understatement chop.

This is a chess perennial, furnishing the chess blogosphere as much material as Neonatology Associates has furnished the tax blogger.

Perhaps Judge Foley didn’t read Judge Laro’s opinion yesterday in Bonnie J. Angle, more particularly described in my blogpost “Concession Doesn’t Equal Settlement,” 2/22/16.

But Danny J. Fabricant, Docket No. 25843-14, filed 2/23/16 is situated in AZ, and that’s Ninth Circuit country. IRS folds, fifteen (count ‘em, fifteen) days before trial. So a Knudsen II costs award is in Danny’s future.

Unless.

Danny should think twice before taking Judge Foley’s advice “…that the parties file, on or before March 23, 2016, either a stipulation of settled issues, or in the alternative, a joint status report. “ Order, at p. 1.

Remember, Barbara Jane Knudsen never stipulated to anything. And joint status report sounds like negotiation to me.

Negotiation means settlement, and settlement means no Section 7430 costs.

Maybe a Rule 161 or 162 reconsideration or vacation is in order. Or a motion for entry of decision. But don’t take the poisoned pawn.

NOTE- Of course, the foregoing should not be construed, and may not be used, as (a) legal advice, or (b) to abate in whole or in part any interest or penalties for, related to, or in connection with any tax or imposition by any governmental authority having or asserting jurisdiction, or (c) solicitation of retention or employment, or for the furnishing of legal or non-legal services, or (d) to create a client-attorney relationship or privilege.

All recipients hereof are advised that a qualified common interest privilege is asserted, both as to the substance of this communication or any claims in connection herewith or in consequence hereof.

Not for the Ninth Circuit, Anyway

Long-time readers may remember the story of Barbara Jane Knudsen and her intervening ex, Kurt, as adumbrated by my blogpost “Concession Equals Settlement,” 4/1/13. Then, said Ch J Michael B (“Iron Mike”) Thornton, IRS’ litigating reversal, granting Barbara Jane innocent spousery, wasn’t a concession, it was a settlement, so no loot for Barbara Jane and her redoubtable barrister, Jan Pierce, Esq.

Poor ol’ Jan only got a Taishoff “good try.” But s/he who laughs last is the one who prevails, and Ninth Circuit blew off Ch J Iron Mike’s ratiocinations and rationales, and Barbara Jane (and, hopefully, Jan Pierce, Esq.) departed with loaded moneybelts.

You can read all about it in Knudsen v. Commissioner (Knudsen II), 793 F.3d 1030 (9th Cir. 2015), rev’g and remanding T.C. Memo. 2013-87 (Knudsen I).

So here’s Bonnie J. Angle, 2016 T. C. Memo. 27, filed 2/22/16, on a Rule 161 in front of Judge Laro. Judge Laro tossed Bonnie on Knudsen I grounds in 2015 T. C. Memo. 92, filed 5/11/15, which I didn’t blog because it was Knudsen I revisited.

OK, so Bonnie now wants a Rule 161 re-think. There were two cases at once, an innocent spousery and a CDP.  The only qualified offer that would trigger Section 7430 (c)(4)(E) and (g) is the innocent spousery, and not the CDP.

But the previous toss is clearly overruled and Golsenized by Knudsen II.

The good news about the qualified offer gambit is that it jumps the two biggest hurdles in the prevailing party steeplechase.

“Under the qualified offer rule of section 7430(c)(4)(E) and (g), a taxpayer may be deemed to be a prevailing party regardless of whether the taxpayer substantially prevailed in the proceeding or of whether the Commissioner’s position in the proceeding was substantially justified.” 2016 T. C. Memo. 27, at p. 12.

But does a concession by IRS mean the petitioner prevailed?

IRS claims no, but the test is timing. Were there negotiations? Did the parties ever evince a meeting of the minds? When did IRS fold? IRS claims Bonnie swapped information with them, but that’s part of the whole litigation process, and Judge Laro isn’t willing to state that the discovery process is a settlement negotiation. And whether IRS was substantially justified or not is irrelevant. The only test is whether the ultimate resolution was equal to or less than the qualified offer, which was less than IRS demanded. Bonnie rejected a proposed stipulated decision from IRS. And IRS folded less than a month before trial.

So is Bonnie getting a check?

No. There’s one more hurdle. Bonnie has some notes for loans she made to a couple of Canadian corporations, that she never bothered to include in her net worth calculations to get under the $2 million net worth bar.

Bonnie claimed they were worthless, but never took a bad debt deduction or tried to collect. Also, Bonnie’s FBAR showed a couple accounts (hi, Judge Holmes) in the Bank of Montreal with six-figure balances, which she also didn’t mention.

Judge Laro: “We note, however, that this evidence casts serious doubt on the veracity of the information petitioner provided to prove she met the net worth requirements.’ 2016 T. C. Memo. 27, at p. 23.

Bonnie is out, but don’t forget Knudsen II. Maybe your clients can make it under the bar.

“Therefore Stay Awake”

I’ve had a good deal to say about continuing legal education programs in these posts. I’m sure all my lawyer-readers (if any) have sat through some that were enlightening, some that were diverting, and some where they wished they could catch up on the sleep they missed when they woke up at three o’clock in the morning, in a cold sweat about things done and left undone.

But even at those last, I must echo the words of a much more exalted writer as the subtitle of today’s sorrowful tale.

Tax Court has issued its periodic list of the suspended, disbarred and restored. You can read it at http://ustaxcourt.gov/press/021916.pdf

Of those therein cited, I chose the case of Mr. H. for my blogpost today. I of course do not name him; he has suffered enough, and clearly has a problem.

Tax Court is on Mr H’s case because his home Commonwealth suspended him, and he failed to self-snitch to Tax Court.

The gravamen of Mr H’s offense was that he disrupted the morning session of a CLE program by falling asleep and snoring, and the afternoon session by talking loudly at the video screen.

There have been occasions when I was sorely tempted to do likewise, but forbore. At least as to loud snoring.

But Mr H had twice been publicly reprimanded by the disciplinary authorities of the aforesaid Commonwealth before his latest appearance before said authorities.

Thus, this latest appearance finally put the cap on matters.

The Commonwealth required Mr H to attend the Lawyers Helping Lawyers program. I cannot too highly praise such organizations, and urge any in need thereof to make haste to get help. In The Empire State all communications between the lawyer and the program are confidential.

In the meantime, stay awake, for you know not the hour.

Judge David Gustafson just can’t help himself…it is in his nature to be obliging. And that, even when the object of his noblesse oblige is only “in small part” deserving thereof.

So today’s designated hitter from Judge Gustafson is Marlene D. Morten, Docket No. 2451-13, filed 2/19/16. You remember Marlene, dilatory bombardier first class?

Truly not? How fleeting is fame. Well, dig my blogpost “Good Nature, Poor Spelling,” 2/1/16.

Judge Gustafson did correct the spelling from the Order in my blogpost abovecited  (“The asserted facts are relevant, discrete, objective, and verifiable or deniable,” Order, at p. 1.). But Marlene catches only a minuscule break, as she seeks reconsideration of Judge Gustafson’s order.

Now your refreshed recollection should show that IRS wanted Judge Gustafson to compel Marlene to respond to some interrogatories. But Judge Gustafson blew that off as moot, because the interrogatories in question dealt with facts which Marlene hadn’t theretofore admitted or responded to. If not directly responded to, those facts were all deemed admitted.

Nothing to reconsider here.

Marlene wants thirty days to respond to the interrogatories. Well, the facts-admitted stuff is history. But the interrogatory seeking names and contact information for witnesses Marlene will call upon the trial is another story. Notwithstanding Marlene’s delaying tactics, she gets time to provide those, although by now, three years into the program, she should have some idea who and where these witnesses might be.

In any case, Marlene’s alleged difficulties in responding to IRS are outweighed by her non-responsiveness to IRS and Judge Gustafson.

“The Court has heretofore made extraordinary accommodations to Ms. Morten in the scheduling of the trial in this case, and those accommodations are at an end. She is not entitled to render herself incommunicado and then to bear no responsibility for the prosecution of this case. Ms. Morten is obliged either to handle her duties under the rules or to hire whatever assistance is needed in order to do so.” Order, at p. 2.

So, Marlene, you’re going to trial in May, ready or not. You have thirty days to name and claim your witnesses.

And, if I may make a discreet suggestion, don’t annoy the Judge. I’ve seen it used as a tactic. It rarely works. Even when the Judge is an Obliging Jurist.

Ends

Y’all will remember the battle of the letters between the Ogden Sunseteers and Thomas M. Comparini and Vicki Comparini, Docket No. 18872-13W, filed 2/18/16.

Well, if you don’t, no reason to be shamefaced about it, check out my blogpost “Arts and the Man,” 10/4/14, when Tom and Vicki starred in 143 T. C. 14, filed 10/2/14.

You’d think after a full-dress T. C., complete with a Judge Mark V. Holmes concurrence, that Tom and Vicki were quids-in, as my UK clients say.

Alas, no. Tom and Vicki were whistleblowers, and Tom turned in a party who was advertising for dirt about a third party’s tax returns. Spotting the numerous chops therefor, Tom filed a Form 211.

There followed the epistolary ping-pong eloquently lamented by Judge Holmes, q.v., as my high-priced colleagues say.

But at the end of the day, IRS brought neither a judicial nor administrative action or proceeding, and of course got no money.

So notwithstanding Tom’s and Vicki’s protestations, STJ Panuthos, detailed to hear this correspondence course, knocks out Tom and Vicki to the same old tune.

“In their response to the pending motion for summary judgment, petitioners contend that respondent’s motion is not supported by any documents. Although petitioners agree that the Tax Court cannot order the Commissioner to commence an administrative or judicial action, petitioners contend that respondent attempts to deny petitioners’ Tax Court appeal rights and that the Tax Court should sanction respondent for constitutional violations and denial of petitioners’ rights. Petitioners also disagree with our holding in Cooper v. Commissioner, 136 T.C. 597. None of petitioners’ objections, however, are relevant to whether respondent has initiated an administrative or judicial action or collected tax proceeds.” Order, at pp. 2-3.

Winning the battle of the letters isn’t enough.