It may not be a change in method of accounting if you change an item to reflect changed external facts. In any case, it’s not a subject for summary J in Thrasys, Inc., et al., 2018 T. C. Memo. 199, filed 12/4/18.

Thrasys was developing hospital operating software for Siemens, the multinational electric outfit, and got a $15 million payment in Year One. Ordinarily, Thrasys reported similar payments as “advance payments,” and deferred these one year forward per Rev. Proc. 2004-34, which lets software developers defer such payments.

IRS claims the $15 million should have been reported in Year One, not Year Two, because Thrasys once before blew the one year deferral and took two. Thrays claims that was a one-off error, not an abandonment of the advance payment deferral method.

If you book items the same way for two years running, you’ve established your method of accounting, and cannot change without the blessing of the Com’r. As a certain ethnic group remarks, “We make the same mistakes three times running and call it a tradition.”

IRS is ready to pounce, nailing Thrasys for recognizing in the wrong year, and also claiming that when Thrasys went from C Corp to S Corp in that same year, the $15 million was “net recognized built-in gain.”

As to the latter, Judge Lauber isn’t going there. But there’s a preliminary problem for IRS’ summary J.

“For at least two reasons we believe that there exist genuine disputes of material fact concerning the correctness of respondent’s submission.

“First, as far as the record reveals, Thrasys treated only one customer payment–the $15 million payment it received from Siemens in [Year One]–as a ‘deposit’ for book or Federal income tax purposes.  That treatment appeared on only one tax return, namely, petitioner’s Form 1120 for [Year One].  (On its Form 1120S for [Year Two} Thrasys shifted the $15 million from the ‘deposit’ category into the ‘deferred revenue category.)  A question of material fact exists as to whether petitioner’s ‘deposit’ treatment displayed the consistency required to constitute a method of accounting on the basis of which Thrasys ‘regularly compute[d]’ its income.  See sec. 446(a), (e).

“Second, a change in method of accounting does not include ‘a change in treatment resulting from a change in underlying facts.”  Sec. 1.446-1(e)(2)(ii)(b), Income Tax Regs.  Thrasys treated the $15 million payment differently from the customer payments it had received during {Three Previous Years], and it did so in accordance with adjustments that an independent auditor had made to its {Year One] financial statement.  Because Thrasys at yearend [Year One] was in technical breach of its software development contract(s) with Siemens, the auditor believed that the $15 million payment might have to be refunded and thus should be reflected on Thrasys’ financial statement as a customer ‘deposit’ offset with a ‘deposit obligation.’ 2018 T. C. Memo. 199, at pp. 16-17.

A “deposit” or “advance payment” characterization goes off on whether the lucky recipient has a good chance of keeping the boodle, or having to disgorge.  But that doesn’t matter for Rev. Proc. 2004-34 purposes, because that states that deferral does not depend upon the chances of having to give the money back based on a condition subsequent.

Nevertheless, the independent auditor’s conclusion may have justified use of the deposit method based upon changed facts.

So no summary J.

A few days back, I got a lengthy proposed comment  to an old blogpost from the losing petitioner. I didn’t bother putting it up. His diatribe (and name-calling) was much of a muchness. In fifty-one (count ‘em, fifty-one) years of doing this, I’ve heard it all: All lawyers are liars (his own lawyer said so); the Tax Court is corrupt; IRS is corrupt; the Circuit Court of Appeals (I don’t remember which) is corrupt; and as my would-be commentator deduced, I am a lawyer, so I am a liar, da capo.….

I learned a long time ago that we lawyers need broad shoulders (and again I thank an old law partner from my early days for the insight); we have to carry the weight of the world.

And when other lawyers go wrong, we have to express our indignation.

Here’s The Community Law Firm, Inc., 2018 T. C. Memo. 198, filed 12/3/18.

The Communitys were up in Tax Court three years ago and lost an off-the-bencher on a CDP where they failed to provide the SO with the info. I didn’t blog it.

Now they want to reinstate an IA on which they defaulted, and again produce no info.

But Judge Lauber has other ammunition in his locker. “In any event IRS records show that petitioner was not current in its tax filing obligations for at least five calendar quarters subsequent to the quarters at issue when the SO made her determination. The SO could properly have rejected a collection alternative on this ground alone.” 2018 T. C. Memo. 198, at pp. 8-9. (Footnote omitted; it says the Communitys claim they asked for an extension for the five quarters, but has no evidence thereof.)

And the Communitys have another CDP going for the quarter before the three quarters at issue.

Now Judge Lauber has not broken the bruised reed nor quenched the smoldering wick, as a much Higher Authority put it, without lots of justification. But today from under the judicial robes he brandishes the Section 6673 yellow card.

“Petitioner is a law firm.  We presume that its principals are conscious of their Federal tax obligations and their responsibility to participate meaningfully in administrative proceedings they have commenced.  Petitioner’s track record in this Court suggests that it may be invoking the CDP process ‘primarily for delay,’ see sec. 6673(a), wasting the resources both of the Government and this Court. Petitioner is warned that it may face penalties if it continues to do this.” 2018 T. C. Memo. 198, at p. 10.

Read and heed.

We’ve seen in recent months how quickly Ch J Maurice B. (”Mighty Mo”) Foley tosses the dilatory or impecunious petitioner, who fails to stump up the sixty Georges supernaculum. Even when he can tease out a cognizable claim from billets doux and random jottings, if there’s no filing fee there’s no case.

Somebody has to pay those hard-laboring clerks and flailing datestampers.

Atiya R. El-Amin, Docket No. 25508-17, filed 12/3/18, has apparently fallen on hard times. Ch J Mighty Mo takes the trouble to parse and piece together from a couple letters, (hi, Judge Holmes), whether from Atiyah or some unnamed assistants, enough to make out a case. Such correspondence arrived on time and in the right place.

But twice did Ch J Mighty Mo adjure Atiyah to pay or seek waiver. But Atiyah sayeth naught. And doeth naught.

One can imagine Ch J Mighty Mo picking up Atiyah’s (and maybe friends’) epistolary efforts and reaching his hand back for the toss.

But Ch J Mighty Mo stays his hand. ”…further review of the amended petition…and of an additional letter from petitioner… shows that such documents incorporated discussed of petitioner’s financial circumstances.” Order, at p. 1.

Judge, I think you meant “such documents incorporated discussion of petitioner’s financial circumstances.”

Howbeit, there is a lesson: Put it all in, whether on the form from the Tax Court website or in a letter or two. Make sure you tell your hardship tale.

Counsel for Pierre L. Broquedis, Docket No. 14214-18, filed 11/30/18, has a tough fight. He wants to strike a bunch of IRS’ exhibits to its answer, and a paragraph thereof, claiming it’s false.

Well, the exhibits are summaries of what IRS hopes to prove, and the paragraph states the attached copy of the SNOD is a true copy thereof.

The Judge With a Heart, STJ Rob’t N Armen, isn’t having any.

“Under Rule 52, Tax Court Rules of Practice and Procedure, the Court may order stricken from any pleading any redundant, immaterial, impertinent, frivolous, or scandalous matter.

“Motions to strike are not 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 on the subject matter of the litigation.” Order, at p. 1.

And in case of doubt, let it all come in and sort it out on the trial.

“Based on a review of the motion papers and the pleadings in this case, the Court concludes that the allegations and exhibits that are the subject of petitioner’s Motion To Strike clearly bear a relationship to the issues in this case. The Court further concludes those allegations and exhibits are therefore best left to a determination on the merits. Lastly, the Court concludes that petitioner has failed to show that material prejudice to him will result by a denial of his Motion To Strike.” Order, at p.3.

There’s six figures of deficiency and chops here, so maybe the motion was worth a try. But I doubt it.

Tax Court enters the last decade of the Twentieth Century, and teeters on the edge of the first decade of the Twenty-First, as the electronic petition is in the wings. And if State yanks your passport at Treasury’s behest because you owe big-time, the Glasshouse Gang has new rules to help you get it back.

Here’s the ganze megillah: https://ustaxcourt.gov/press/113018.pdf

Other changes from previous Congressional legislation are here, too. Interest abatement, innocent spousery, the Federal Rules of Evidence (unalloyed with USDCDC’s nonjury variations), and Form 2 Petition are featured.

The new Form 2  has the passport yank added, although the filing fee is still last on the list. Ch J Maurice B (“Mighty Mo”) Foley is still ready from the getgo to toss the impecunious or the dilatory, so watch it.

Lest we all get too het-up about the coming All-Electronic Era, note this (from Tax Court’s non-existent press office): “Before the Court implements electronic filing of petitions and certain other papers, however, the Court will furnish detailed information about those procedures in the Court’s electronic filing guidelines on the Court’s Web site.”

Cain’t hardly wait.

Getting ready for the great Handelian seasonal singalong, I came across a designated hitter from Judge Mary Ann (“No Cognomens”) Cohen. Judge Cohen tosses IRS’ expert appraiser’s report and grants petitioner’s in limine motion in Donald L. Bren, Docket No. 20942-16, filed 11/29/18.

IRS’ expert appraiser, whom I’ll call Mr. P., will be unavailable to testify on next month’s trial “…because of various family catastrophes recently occurring. The Court indicated an inclination to grant the Motion in Limine but had planned to have voir dire of Mr. P conducted at the commencement of the trial before ruling on the Motion in Limine. In view of Mr. P’s apparent unavailability, however, the Court decided to grant the Motion in Limine upon receipt of an additional filing by petitioner and agreement that Mr. Perdue’s deposition would be marked as an exhibit in this case (not to be received in evidence).” Order, at p. 1.

Turns out that Mr P. discarded paper and deleted electronics he looked at but disregarded in reaching his conclusions.

When IRS responds to Don’s motion to toss Mr P’s testimony, Judge Cohen is less than enthused.

“Respondent’s response posits extreme situations where a prospective expert might investigate or review material that is not reduced to paper or electronic methods of preservation. Respondent ignores the facts of this situation where the expert admittedly destroyed materials after deciding to reject their use in his analysis. Data considered and rejected may be as significant as data considered and adopted. Deliberate omission and rejection of data and the reasoning of the analysis are the essence of cross-examination of an expert witness, and impairing cross-examination by destroying rather than producing such materials is inherently prejudicial to the adverse party. In this case, the explanation of why the expert deviated from previously expressed opinions deserves careful examination. Under these particular circumstances, it is not necessary to address other cases and their similarities or distinctions.” Order, at pp. 1-2.

Tossing Mr P only torpedoes IRS’ increased deficiency, as to which IRS has burden of proof. Don still has burden of proof as to the basic deficiency.

And Don doesn’t have a walkover. “The time spent at trial will best be focused on the reliability of petitioner’s expert’s opinion.” Order, at p. 2.

The material your expert reviews may be “despised, rejected,” but don’t shred or delete unless you want to be the one “acquainted with grief.”

No, not Pres. Nixon’s 1971 initiative that has been either a blessing or a curse (depending upon your point of view). This is IRS’ ongoing fight to tax to the uttermost limits of the law the medical MaryJaners in the 33 (count ‘em, 33) States where medical vegetation is legal.

And IRS slugs successfully the wannabe “gold standard” of the Golden State’s medico-potteries, Patients Mutual Assistance Collective Corporation d.b.a. Harborside Health Center, 151 T. C. 11, filed 11/29/18.

The fight is over COGS (Cost Of Goods Sold), an adjustment to gross receipts, not a deduction. Per Section 280E, P-MAC can’t deduct expenses for trafficking in a controlled substance, which cannabis is, despite attempts to remove it from the schedule; Judge Holmes has a list of eight such attempts, 151 T. C. 11, at p. 36, all unsuccessful.

If you’re coming late to the party, see my blogposts “Everybody Must Get Stoned,” 8/3/12, and “He Canna Care,” 10/22/15. Judge Holmes cites extensively to the cases I discussed.

So if COGS are all this is about (and it is; see below for the rest), can P-MAC capitalize per Section 263A, or are they stuck as “resellers” with the much more restrictive Section 471 rules?

P-MAC first claims that DOJ stiped out with prejudice their attempted civil forfeiture of the premises wherein P-MAC operated. But that’s no basis for claim preclusion, as DOJ and P-MAC couldn’t have tried the tax issues in the civil forfeiture. And the case P-MAC cites goes more to election of remedies than claim preclusion.

Next is the obligatory dictionary chaw. Judge Holmes twice quotes Shakespeare, and every dictionary the parties and he can find going back to 1893 (I kid you not; 151 T. C. 11, at pp. 29-30). The issue is where the words following the phrase “consists of” in Section 280E is an exhaustive or non-exhaustive list.

Read the opinion. Exhaustive or non-exhaustive? I’m exhausted.

If exhaustive, P-MAC wins, but Section 280E is eviscerated. Can’t have that. And while Congress prevents DOJ from spending taxpayer cash on medico-pottery-busting, that doesn’t obliterate Section 280E as far as IRS is concerned; they’re Treasury, not Justice.

I’m sure some of my readers are saying “It’s not justice, that’s for sure.”

Howbeit, Judge Holmes finds that allowing P-MAC Section 263A capitalization would allow an end-run around Section 280-E and Section 263A(2), which says if an expense wasn’t allowable before Section 263A took effect, it can’t be capitalized now. “So if something wasn’t deductible before Congress enacted section 263A, taxpayers cannot use that section to capitalize it.  Section 263A makes taxpayers defer the benefit of what used to be deductions–it doesn’t shower that as grace on those previously damned.” 151 T. C. 11, at p. 53.

Judge Holmes the Puritan?

On facts and circumstances, P-MAC is only running a pottery, no other trade or business; its ancillary services (mandated by CA law) and gift shop activities only provide one-half of one percent of the gross. Their marketing and branding aren’t separate trades or businesses, because they weren’t conducted or reported that way.

And on facts and circumstances, P-MAC is a “reseller,” not a “producer,” per Section 471, so their COGS are substantially reduced. They don’t do enough with the stuff and keep it under tight enough wraps.

I have to give P-MAC’s attorneys a Taishoff “good try.” The found P-MAC a Constitutional argument. If they can’t treat their costs as COGS, they’re being taxed on more than their gross income, and the Sixteenth Amendment prohibits that. (Yes, protesters, it is valid).

“Harborside would get COGS adjustments for its direct inventory costs no matter what–even if it was trafficking cocaine or any other controlled substance not legal under California law.  The only things Harborside doesn’t get are indirect inventory costs granted as deductions and then deferred under section 263A.

“The section 263A capitalization rules don’t apply to drug traffickers. Unlike most businesses, drug traffickers can’t capitalize indirect expenses beyond what’s listed in the section 471 regulations.  Section 263A expressly prohibits capitalizing expenses that wouldn’t otherwise be deductible, and drug traffickers don’t get deductions.  Because federal law labels Harborside a drug trafficker, it must calculate its COGS according to section 471.” 151 T. C. Memo. at p. 56.

Now what’s missing from this picture? Hint, Judge Holmes is writing this opinion for a unanimous bench.

Those of my readers who’ve stuck with me through this laborious trudge will cry out with one voice “Section 6751(b) Boss Hoss!”

“This leaves only the issue of whether Harborside owes accuracy-related penalties under section 6662(a).  We will address this issue in a separate opinion.” 151 T. C. 11, at p. 62.

Cain’t hardly wait.

The free-and-easy discovery practice in Tax Court is certainly a relief to the weary practitioner, accustomed to the endless scrapping, jousting and push-and-shove of State court (and even sometimes Federal court), with endless appeals to the overburdened courts to play schoolyard monitor.

“Play nice” and “talk among yourselves” are the watchwords.

Except.

Here’s Judge David Gustafson, the blogger’s obliging friend, with a designated hitter and a discovery suggestion for IRS in Palmolive Building Investors, LLC, DK Palmolive Building Investors Participants, LLC, Tax Matters Partner, Docket No. 23444-14, filed 11/28/18.

IRS wants to amend its answer to KO Mike Ehrmann’s appraisal of the Palmolive façade. IRS claims Mike was a “promoter” of a dodge, thus unworthy of the Palmolives’ confidence.

Mike’s been around and had a bumpy time of it, finally being enjoined by USDCNDOH “from preparing any further property appraisals for federal tax purposes.” See my blogpost “The Façade Collapses – Redivivus,” 6/20/14.

But the Palmolives were a wee bit casual in pleading good faith reliance. “(The petition did not explicitly assert a defense of ‘reasonable cause’ pursuant to section 6664(c)(1). Palmolive has never sought leave to amend the petition to assert such a defense.)” Order, at p. 2.

Nevertheless, IRS is also a trifle ambiguous. Though the Palmolives’ ambush claims are thrust aside, Judge Gustafson wants IRS to bukh with some more specificity. And he uses a tried-and-true method familiar to all of us.

“Palmolive correctly states that ‘Respondent has provided no facts to support his new promoter allegation.’ Given the petition’s lack of specificity about penalty defenses, this defect does not incline us to deny the motion for leave. However, we will require the Commissioner to communicate to Palmolive detailed allegations about its contention that Mr. Ehrmann was a promoter, so that Palmolive can prepare for trial.” Order, at p. 5.

The bill of particulars is alive and well in Tax Court.

I do not know if Judge Holmes ever heard these words at a funeral service, but he certainly reflects on that seventeenth-century sentiment in Estate of Lydia Ramirez, Deceased, Rowena L. Ramirez, Special Administrator, 2018 T. C. Memo. 196, filed 11/28/18.

The late Lydia was a busy entrepreneur until illness caught up with her. She ran businesses that she reported as active, and ran a bunch of rental real estate she reported as passive, but never elected aggregation directly, by PLR or by Rev. Proc. 2011-34, 2011-24 I.R.B. 875. Nor had she logs, timesheets or GPS readouts to establish professionalism when daughter Rowena had to deal with the two years at issue.

IRS disallowed the late Lydia’s pro status, thus preventing her passive losses from offsetting active gains. And Judge Holmes agrees.

It’s the usual fact-bound Section 469 mélange. Rowena’s claim that she often visited her late mother collides with Judge Holmes’ arithmetic and Rowena’s day job. And her mother’s many illnesses (“She was suffering from hypertension, diabetes, emphysema, subclinical congestive heart failure, and diffuse microvascular disease.” 2018 T. C. Memo. 196, at p. 9) may have hindered her work activity, despite Rowena’s claim otherwise.

So why am I telling you all this? And why the quote from a burial service?

Well, IRS gave the late Lydia a SNOD before she became the late Lydia. And Lydia petitioned. But prior to trial, the late Lydia succumbed, so Sp’l Adm’r Rowena took up the fight.

And on said trial IRS failed to put in evidence the Boss Hoss Section 6751(b) sign-off to sustain the five-and-ten chop that would clearly ensue.

So we’re standing at the Graev.

But who has the burden of production, the late Lydia (an individual), the estate of the late Lydia (a “taxpayer” but not an individual), or the IRS (the usual suspect)?

When the tax liability is that of the estate, Tax Court has treated the estate as an individual for Section 7491(c) production purposes. But in all the cases Judge Holmes can find, IRS had the Boss Hoss sign-off and got it into evidence. So the distinction made no difference.

Here it does. And they key is the nature of the proceeding wherein the chops are in play.

Judge Holmes: “We need to focus…on the nature of the proceeding.  Is this case a proceeding with respect to the liability of Ramirez as an individual or of her estate?  We think the answer is that it is a proceeding to determine the liability of an individual.  Even though Ramirez’s additional tax liability had not been assessed at the time of her death, it was established and constituted a debt due the United States while she was still alive.” 2018 T. C. Memo. 196, at p. 33 (Footnotes and citations omitted, but read them for your next memo of law).

Remember, the Section 6662 chops IRS wants are treated and assessed as tax.

Burden of production on IRS, so without the Boss Hoss sign-off, Sp’l Adm’r Rowena wins on the chops.

That’s Judge Ashford’s admonition to Glenn Cunningham Ballard and Yu-Yuan Pu, 2018 T. C. Sum. Op. 53, filed 11/27/18, but it especially goes for Glenn. It seems he’s a pro, but the wrong kind.

Glenn “…was a certified public accountant (C.P.A.).  He earned a bachelor’s degree in business administration with a concentration in accounting, and a master’s degree in taxation.  During the years at issue Mr. Ballard attended part time (Saturdays from August to May with a brief break in December) the University of California, Berkeley, for a master’s degree in business administration (M.B.A.).” 2018 T. C. Sum. Op. 53, at pp. 3-4.

Glenn also ran seven (count ‘em, seven) rental properties, but only two were in his home State of CA; the remainder were across the continent in GA. Yu-Yuan claimed she helped, but she was raising three small children at the time, and whatever she did was investor stuff, not operator stuff.

Glenn’s substantiation of hours spent real estating fell short. He had logs, but they weren’t contemporaneous.

“These logs were not kept contemporaneously; Mr. Ballard created them from his recollection of activities in conjunction with reviewing emails, phone records, receipts, rental applications, and rental agreements.  With respect to Ms. Pu’s hours in particular, many of them were for nonmanagerial activities, i.e, investor-type activities.  Petitioners did not provide time logs for [two of the three years at issue] but provided to respondent on the day of trial copies of documents consisting of invoices, receipts, checks, rental applications, rental agreements, and letters.  Except to the extent allowed by application of section 469(i), respondent disallowed petitioners’ claimed loss deductions for the years at issue because their residential rental activities were passive activities in the context of section 469.” 2018 T. C. Sum. Op. 53, at pp. 5-6.

Even allowing (without deciding) that Glenn and Yu-Yuan were in a real estate trade or business, and that they both materially participated, they didn’t substantiate the hours.

And that’s where the chops come in. IRS wins the reopener to let in the Section 6751(b) Boss Hoss signoff, so Glenn must show good faith.

“Given Mr. Ballard’s experience, knowledge, and education, there is no justification for his misunderstanding of the law.  He testified that he has never dealt with tax preparation in his work experience although he is a C.P.A. with a professional degree in taxation.  Mr. Ballard has owned residential rental properties for over 10 years.  His professional background and real estate experience make it unreasonable for him to conduct these activities and not properly document the time that was invested into petitioners’ residential rental properties.  Accordingly, we sustain respondent’s determination regarding the accuracy-related penalties….” 2018 T. C. Sum. Op. 53, at pp. 19-20.

Glenn may not have been a real estate pro, but he was enough of a tax pro to know.