I’m going back a long time, remembering a book from my boyhood, but today we have a full-dress T. C. hitting the shareholders of the S Corp which provides management services to a CA medical pottery with the Section 280E deduction-killer.

Here’s Alternative Health Care Advocates, et al., 151 T. C. 13, filed 12/20/18, handing out all the goodies they’ve acquired from their members. And fighting about COGS, because their Section 263A argument for deductions founders on Section 280E. Judge Pugh rehashes (no pun intended) Martin Olive and P-MAC, both of which I’ve blogged in extenso. You’ll find the citations to these cases in the opinion.

The old “trafficking” dictionary-chaw is still around, but it’s a clear loser for the Alternatives. Their non-boo sales are a minuscule part of the gross. And they’re not a “producer” anyway, only a “reseller,” so whatever IRS gives them for COGS is what Section 471 allows.

The als have a Sub S that handles payroll, rent, advertising, hiring and firing employees for the Alternatives. The als want to deduct from the management fees their sub S get from the Alternatives the expenses they pay for the foregoing, claiming they’re not traffickers. But the sub S only works for the Alternatives, although they were hoping to pick up other potteries to service.

Judge Pugh: “Because Alternative and [sub S] are legally separate entities, we must analyze whether [sub S]’ own business activities also constituted ‘trafficking in controlled substances’ as contemplated by section 280E.  Petitioners argue that, as a management services company, [sub S] did not itself engage in the purchase and sale of marijuana.  But the only difference between what Alternative did and what [sub S] did (since Alternative acted only through [sub S]) is that Alternative had title to the marijuana and [sub S] did not. [Sub S] employees were directly involved in the provision of medical marijuana to the patient members of Alternative’s dispensary.  While [sub S] and Alternative were legally separate, [sub S] employees were engaged in the purchase and sale of marijuana (albeit on behalf of Alternative); that was [sub S]’ primary business. We do not read the term ‘trafficking’ to require [sub S] to have had title to the marijuana its employees were purchasing and selling.  Neither that section nor the nontax statute on trafficking limits application to sales on one’s own behalf rather than on behalf of another.  Without clear authority, we will not read such a limitation into these provisions.” 151 T. C. 13, at pp. 28-29.

This jogged my memory of Lou Boudreau, player-manager of the Cleveland Indians, and his book of that name. The manager is also a player.

One of the commonest bounces of collection alternatives at Appeals is failure to withhold or pay estimateds for years subsequent to the year(s) at issue; one has to come clean to be clean, or show poverty in the extreme.

Here’s Douglas Maitland Reid & Linda Marie Reid, Docket No. 17152-17L, filed 12/19/18. That’s Dr Linda Marie Reid to you, but it doesn’t help, as Doug is self-employed and they have four full (and maybe a fifth) years of tax due but withholdings under the 90% mark by a long way. See Order at p. 4 for the full rundown.

STJ Armen, The Judge With a Heart, observes in this designated hitter that the ASO offered the Reids an IA based on their own numbers, which they rejected.

“…IRS guidelines with respect to collection alternatives direct that the taxpayer must be in current compliance with filing and estimated payment obligations. Moreover, it is not an abuse of discretion for the ASO to decline to consider an installment agreement or offer-in-compromise where no specific collection alternative proposal is ever placed before the reviewing officer. Stated otherwise, it is the obligation of the taxpayer, not the reviewing officer, to start negotiations regarding collection alternatives by making in the first instance a specific proposal.

“Petitioners rejected the ASO’s initial proposed installment agreement… and ASO’s counter-proposal… on the grounds that petitioners could not afford to make the payments, even though the ASO’s counterproposal was based on the financial information provided by petitioners themselves.” Order, at p. 7.

Unless you’re truly destitute, there’s no free ride at a CDP.

Who Cares?

Whether she’s a partner (direct or indirect), or not, Judge Holmes is on the case. And so Ann S. Carrino, et al., Docket No. 27376-09, filed 12/18/18, doesn’t get a new SNOD, and IRS doesn’t get to fight over whether Ann is a direct or indirect partner in her ex’s LLC.

Even before doing the Rule 155 beancount, both Ann and IRS filed Rule 161 reconsideration. And Judge Holmes shoots them both down.

IRS wants Judge Holmes to make clear that all he decided was that Ann S. wasn’t a direct partner; IRS wants to fight about Ann being an indirect partner. But Tax Court has no jurisdiction under TEFRA to decide which partner is direct or indirect. Based on her ex’s late filed amended return, all Ann is, is a holder of a community-property interest under CA law. She won, and so the FPAA that conferred jurisdiction on Tax Court is wrong when it claims she was a partner.

Ann says, OK, that means that the SNOD I got was invalid, so I get a new one (and maybe SOL has run).

Not quite, says Judge Holmes.

“Ms. Carrino argues in her individual case that, because we have jurisdiction in the partnership case, respondent had no right to issue her a notice of deficiency that asserted she had failed to report her share of community-property income. She asserts that ‘Whether the Court’s determination that [she] was not a partner in CR LP makes it an affected item or an item which has become a nonpartnership item . . . [she] is entitled to a superseding deficiency notice from the Commissioner if the taxability of her community property interest in 2003 in CR LLC remains an issue with [her ex].” This assertion, in turn, seems to flow from her view that her community-property interest in her ex’s partnership interest becomes an ‘affected item’ under TEFRA with her victory in the partnership case.

“But this is not true. The central holding in the individual case was that none of this mattered — under California’s community-property rules, she is treated as receiving income in 2003 regardless of whether she was a partner in her husband’s partnership. This means that the notice of deficiency was determining an adjustment to a nonpartnership item. Once she filed a timely petition challenging that valid notice of deficiency we had jurisdiction to redetermine that determination.” Order, at p. 2.

Vintage Holmes.

We think of the Section 6663 75% chop in the singular, the famous ten (count ‘em, ten) badges of fraud, applied to a phony return. But as the insomniac telehucksters like to yell to jolt us awake, “But wait! There’s more!”

And more is the Section 6651(f) 75% add-on “if any failure to file a return is fraudulent.” Or maybe it’s a chop of a different color.

IRS misses the boat and gets its motion to amend its answer to conform to the proof shot down, because they never previously mentioned Section 6651(f) to Roger H. Durand II, Docket No. 16273-17, filed 12/18/18.

That’s the Rev. Durand to you, but the Rev. is apparently a non-filer for nine (count ‘em, nine) years, and has run up a half-million bucks of deficiencies the while. So IRS wants the 75% Section 6663 chop, or at least the 20% understatement chop, for each. The Rev. Durand did file for the nine years in two tranches, the first for the four oldest years and the second for the balance, long after they were due.

The Rev. Durand and IRS went to trial, but nobody said palabra una about Section 6651(f).

Two weeks after both sides rested, the record was closed, and Judge David Gustafson had settled down to thirteen hundred pages or so of light reading, IRS awoke and moved to amend its answer to conform with Section 6651(f). The Rev. Durand revved up and opposed.

Hence today’s designated hitter.

“These are two distinct 75% penalties–one for filing a fraudulent return, sec. 6663, and the other for fraudulently failing to file a return, sec. 6651(f). The Commissioner minimizes this distinction when he complains that Rev. Durand’s opposition ‘opaquely mentions “different time frames that are relevant to § 6651(f) compared to § 6663” without explaining what “different time frames” he means. (Doc. 61 at 2.) However, we think Rev. Durand is correct in noting these “different time frames”.” Order, at pp. 2-3.

Remember, Section 6663(a) covers a filed return that intentionally and willfully misstates material facts. So the fraud is committed at the filing date of the return. But Section 6651(f) covers the non-filing of a return with intent to conceal material facts (that the concealer has taxable income and that tax is due thereon) at the date when a return disclosing same would be due.

So if IRS wants to hang Rev. Durand, the magic date is when each of the non-filed years’ returns were due, but not filed. But those years are long before the years when the belated returns were filed, and whatever were the Rev. Durand’s motivations when he filed, that’s nothing to the point of what they were years before.

“The section 6651(f) penalty that the Commissioner now seeks to plead is different from the section 6663 penalty that the Commissioner did plead, and some of the facts that would be critical under section 6651(f) are different from the facts that would be relevant under section 6663. Rev. Durand did not have occasion to prepare and present proof as to those facts critical to the section 6651(f) penalty that the Commissioner now seeks to add after the trial has been concluded.” Order, at pp. 3-4.

Nothing like the transparency of the Internal Revenue Code.

No, not a variant on the Adler-Ross 1954 musical comedy tune, rather this is the story of the divorce case between now-or-former attorney Bruce Scholes and Mary Fernando, which ended with Mary splitting some AZ property with Mary Louise Sholes, 2018 T. C. Memo. 203, filed 12/17/18, and Mary Louise’s late husband (who invested therein at Bruce’s behest), and Mary Fernando getting all the NM property.

Mary Fernando claimed Bruce did a fraudulent conveyance to Mary Louise and Mary Louise’s late spouse. The idea was to oust Fernando of her community property interests in the foregoing. In the course of the jurisprudential fracas, there was also a criminal money-laundering case. Mary Louise claims ran up some $1.2 million in legal and professional fees over three (count ‘em, three) years. And collected no rents from any of the properties involved, as son Bruce was living there rent-free.

Note this is a petition from a CDP. Mary Louise never got the SNODs, so she got de novo treatment on liability.

Bruce carries the ball for Mary Louise on the trial, as she is infirm.

Judge Cohen: “Notwithstanding multiple opportunities to provide specific descriptions of the services rendered by various lawyers and firms involved in the various legal battles, petitioner and [Bruce] failed to do so.  Instead, to support their contentions that all of the amounts were properly deducted, they have relied on canceled checks, summaries of those checks, and vague explanations of what particular lawyers did.  The inclusion of payments to caregivers for [Bruce’s] children, by checks clearly marked as for child care, undermines the reliability of their generalizations.  Petitioner belatedly offered to concede those clearly personal amounts, but that concession does not cure the misrepresentation of the nature of the payments in the summary of legal and professional fees petitioner prepared to support the deductions claimed on her tax returns.” 2018 T. C. Memo. 203, at p. 8.

And here’s the kicker.

“Deductibility of legal fees depends on the origin and character of the claim and not on its potential consequences to the taxpayer.  United States v. Gilmore, 372 U.S. 39, 49-52 (1963).  If the origin of the claim is a marital relationship, the legal expenses are nondeductible even if the outcome affects income-producing property of the taxpayer.  Fleischman v. Commissioner, 45 T.C. 439, 446 (1966); Lucas v. Commissioner, T.C. Memo. 2018-80; Barry v. Commissioner, T.C. Memo. 2017-237.” 2018 T. C. Memo. 203, at p. 11.

Even assuming the properties were held for production of income, the paucity of evidence precludes even a Cohan approximation of deductible expenses.

So if “all you see are silhouettes,” it isn’t enough.

Maybe Not, But You Have To Prove It

Judge David Gustafson is down with Scotland’s Greatest. He won’t fault good faith, but he needs to see facts that manifest the good faith of Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner, Docket No. 23444-14, filed 12/14/18, a special day at our house.

The Palmolives want partial summary J that they took the $33 million façade deduction that got blown away back in October of 2017 (see my blogpost “No Joy Forever – Because Golsen,” 10/10/17, a/k/a Palmolive I) in good faith and with reasonable cause, per Section 6664, to prevent substantial overvaluation chops. Judge Gustafson, smarting from 1 Cir’s shootdown of Tax Court in Gordo and Lorna Kaufman, refused to apply 1 Cir to the Palmolives, who are 7 Cir domiciliaries. But there was no other appellate learning.

Tax Court generally doesn’t hand out chops on first-impression cases, but good faith and reasonable cause are matters of fact. True, since 1 Cir reversed Tax Court, there is room for good-faith dispute, but what did the Palmolives do besides cite 1 Cir?

“Palmolive contends that it has a reasonable cause and good faith defense for the portion of underpayment attributable to its failure to comply with this regulation. Though this contention is insufficient to entitle Palmolive to partial summary judgment on ‘reasonable cause’, we do accept Palmolive’s argument that our analysis of its non-compliance with section 1.170A-14(g)(2) was an issue of first impression in Palmolive I. However, that alone does not result in our holding that Palmolive had reasonable cause and acted in good faith. See sec. 1.6664-4(b)(1), Income Tax Regs. Deciding whether Palmolive had reasonable cause and good faith for its understatement based, in part, on an alleged honest misunderstanding of law, will require the Court to determine whether that misunderstanding was ‘reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer.’ Some of those facts and circumstances are disputed by the parties.” Order, at p. 6. (Citations omitted).

Even though Mike Ehrmann’s appraisal was stipulated in as a qualified appraisal for Reg. § 1.170A-13(c)(3) purposes, there remains the fact question whether it was too good to be true, and what the Palmolives did to confirm it. They didn’t claim to have consulted other authorities; did they do anything else?

Lest we think Judge Gustafson is whistling past the Graevyard, he notes that the cross-motions regarding the Section 6751(b) Boss Hoss sign-offs for the chops remain pending.

But Palmolives, don’t get your hopes up. The Boss Hosses won’t be the subject of a trial.

A much more exalted personage even than Ch J Maurice B (“Mighty Mo”) Foley gives me the title for this blogpost, Michael T. Sestak, Docket No. 17286-18, filed 12/14/18, a special day in our house.

Mike claims IRS failed to send the SNOD to his last-known address.

IRS points to a handwritten letter from Mike that sets forth his address and directs that all correspondence be sent to him at Pine Knot, TN. Mike sent this two (count ‘em, two) years before the SNOD was mailed.

Mike claims he gave the IRS his complete address. IRS says no, Mike didn’t include Mike’s prison registration number.

Despite this season of goodwill, Ch J Mighty Mo isn’t letting IRS get by.

“… I.R.M. 4.8.9.8.2.8 (07-09-2013) states, in pertinent part: Incarcerated Taxpayers *******

“2. The address in the Letter 531, Notice of Deficiency, should be where the taxpayer is incarcerated and should reference the prisoner locator number if available.

“3. For federal prison inmates, the prisoner locator number and address can be obtained from the Bureau of Prisons web site.” Order, at p. 2.

DC Cir has held that IRS should make a reasonably diligent effort to find out a party’s address if there’s doubt that the address they have won’t reach that party.

So let IRS explain why they didn’t check out Mike’s prisoner locator number.

When a newly-minted colleague announces gleefully that s/he has “passed the bar,” my invariable reply is “My condolences.” I’m speaking only partially tongue-in-cheek (although how one can speak at all with tongue in cheek is a good question).

This can be an exhilarating profession, an intriguing life’s work, a ringside seat on the Human Comedy; it can also be stress-inducing, relationship-destroying and dehumanizing.

All that to one side, it can also destroy one’s business tuition deduction. I’ve blogged this before (see my blogpost “Moaning of the Bar,” 11/5/18).

Today’s candidate is another bright, hardworking voyager who comes from away to our shores to learn and earn, Serge Raymond Banini, Docket No. 6699-18S, filed 12/13/18. Serge earns a designated hitter from STJ Diana L Leyden, but IRS gets partial summary J tossing Serge’s deductions.

Serge added to his Cameroon BA in chemistry with a Ph.D. at West Virginia University, and signed up as a Patent Technical Adviser (Life Sciences) with a white-shoe. Serge claims the white-shoe wanted him to get admitted to MA Bar to get his job, but when show-and-tell comes around, his acceptance letter from the white-shoe doesn’t mention lawyering, only helping lawyers understand the life sciences.

The white-shoe did lend him the money for his law school tuition at no interest, but that isn’t enough. Neither is it that having his MA admission helped Serge do his work better.

“…petitioner asserts that the deduction of his legal education expenses should be allowed at least in part because some of the law school courses were only taken to maintain and improve his skills as a patent advisor. However, the regulation provides that expenditures for education which qualify a taxpayer for a new trade or business are not deductible even though the education may maintain or improve skills required for his employment. Sec. 1.162-5(b)(1), Income Tax Regs.; see Bodley v. Commissioner, 56 T.C. 1357, 1361 (1971). The undisputed material facts indicate that attending law school qualified petitioner for the new trade or business of a practicing attorney. Therefore, no partial deduction is allowed even if the education may have maintained or improved petitioner’s skills required for his employment as a patent advisor.” Order, at p. 5.

So summary J for IRS knocking off Serge’s tuition deductions.

Another reason why I express my condolences to those newly-admitted to this crazy profession.

That’s Ch J Maurice B (“Mighty Mo”) Foley, when he spots a petitioner who hasn’t thrown the sixty coins in the Tax Court fountain when s/he posted the petition. He bounces the petitioner for want of jurisdiction, with no warnings or second chances.

And today Ch J Mighty Mo is so fast he outruns IRS’ counsel to toss Edward Thomas Kennedy, Docket No. 21004-18, filed 12/13/18.

Edward Thomas sent in an application for waiver of the filing fee with his petition in October, so this isn’t the usual one-week-or-less trademark toss from Ch J Mighty Mo.

But in November, Ch J Mighty Mo denied Edward Thomas’ poverty pitch, and told him to stump up or stand down. Edward Thomas moved for Ch J Mighty Mo to recuse himself. As the papers aren’t available online, I cannot tell on what grounds Edward Thomas relied.

In any case, if there’s no jurisdiction there’s no reason for anyone to recuse himself, so on Monday last Ch J Mighty Mo tossed Edward Thomas for failure to ante up.

IRS’ counsel didn’t catch the Monday bounce, so yesterday he banged in a motion to dismiss for failure to state a claim.

Too late, so that motion gets bounced.

But the irrepressible Edward Thomas, yesterday, throws in a motion “for a new trial,” in a case that (a) has been dismissed, and (b) where there never was a trial to begin with.

Neither Edward Thomas nor IRS’ counsel can outrun Ch J Mighty Mo when there’s money at stake.

As Judge Goeke points out in Raghunathan Sarma and Gaile Sarma, 2018 T. C. Memo. 201, filed 12/12/18, at p. 44, footnote 11: “Congress repealed the TEFRA procedures in the Bipartisan Budget Act of 2015, Pub. L. No. 114-74, sec. 1101(a), 129 Stat. at 625.”

And I, for one, am glad.

If you are still interested in this labyrinthian concoction, you can read all 48 pages of Judge Goeke’s dissection of Rag’s mix-and-match, three-ring LLC circus, which marries the usual recognized loss with unrecognized gain to bury recognized gain.

IRS goofed when they handed out NBAPs to small-partnership LLCs, but Section 6231(g)(1) bails out IRS, as they had a reasonable basis for issuing same, and bailed when they found their mistake.

And even if a couple of the three-ring LLPs weren’t TEFRA-bait, it turns out that one of them was big enough to warrant TEFRA, and that brings in Section 6229 to save the SOL.

Taishoff comment: I see an appeal on this one.

Finally, the famous Woods dictum: “In dicta, responding to a point raised in an amicus brief, the Supreme Court in Woods observed that where a partnership is a sham and disregarded for tax purposes, the determination of the partner’s outside basis may not require a partner-level determination to adjust outside basis and thus the adjustment may be computational.  Woods, 571 U.S. at 42 n.2.  The Court stated that the amici’s argument ‘assumes that the underpayment would not be exempt from deficiency proceedings because it would rest on outside basis.’  Id.  The Court further observed: ‘Even an underpayment attributable to an affected item is exempt so long as the affected item does not ‘require partner-level determinations,’ * * * and it is not readily apparent why additional partner level determinations would be required before adjusting outside basis in a sham partnership.’  Id. (citations omitted).

“Woods did not, however, answer the question of whether the partner-level adjustment of outside basis incident to a deficiency determination is computational and the Commissioner may directly assess the resulting tax against the purported partners or whether the adjustment requires a partner-level determination and the issuance of a notice of deficiency.” 2018 T. C. Memo. 201, at pp. 41-42.

If you are not stunned by the foregoing, try this: “While the Supreme Court’s dicta in Woods gives us pause, we conclude that the adjustment of outside basis in a sham partnership requires a partner-level determination.  No Court of Appeals has discussed the question of whether the adjustment of outside basis could be computational.  At this late date in the life of the TEFRA partnership provisions, it would be unwise for us to introduce uncertainty in the application of this well-worn law.  It is logical, as the Supreme Court suggests, to conclude Lincoln’s outside basis in its Kearney partnership interest was zero.” 2018 T. C. Memo. 201, at p. 44. (Footnote omitted, but I set it forth at the head hereof).

So I again quote Tommy Hobbes: ““When men write whole volumes of such stuffe, are they not Mad, or intend to make others so?” Leviathan, Book VIII (1651).

Edited to add, 11/13/20: No appeal so far, but a Rule 161 goes nowhere.