A heartwarmer for an elderly chap like me comes from Liz Wallace at KPMG (thanks, Liz) and the Sixth Circuit. Sixth Circuit revisits their sixtysix year old decision in Cleveland Allerton Hotel, Inc. v. Comm’r, 166 F.2d 805 (6th Cir. 1948), and finds it’s just as good today as it ever was.

I won’t ask if you remember Cleveland Allerton, because I sure don’t. It involved a hotel operator enmeshed in a disastrous lease. CA could buy the hotel for way less than it would be paying over the remaining lease term, and negotiated a buyout. Of course, the owner-lessor charged CA well above the odds, to compensate for the lost income stream.

IRS claimed that the entire buyout price was acquisition cost of the hotel, and must be capitalized. But, back in the day, Sixth Circuit agreed with CA, saying that the purchase price was FMV (which CA backed up with an appraisal), and the overage was a currently deductible business expense, to be rid of the nettlesome lease.

Well, IRS is back, and this time its target is ABC Beverage Corporation, No. 13-1701, decided 6/13/14, while I was flying back from the Magnolia City. Note that the full caption is ABC Beverage Corporation v. United States of America, because ABC stumped up the tax and sued for a refund; USDC Western District of Michigan gave ABC a “thumbs up”, and IRS appealed.

IRS loses. CA may be old, but it’s good, and intervening learning from the Supremes, and an amendment to Section 167(c) don’t change Sixth Circuit’s mind.

IRS claims four (count ‘em, four) Supreme decisions wipe out CA.

The first, Millinery Center Building Corp. v. Commissioner, 350 U.S. 456 (1956), doesn’t apply because the Milliners didn’t prove that the lease they bought was burdensome. So essentially they paid FMV, as there was no burdensome lease to get out of.

The second, Woodward v. Commissioner, 397 U.S. 572 (1970), involved legal, brokerage, accounting and appraising fees for a dissident stockholder buyout. But there the issue was whether these costs were part and parcel of the acquisition of the dissenters’ shares, and the Supremes said they were. The test is not the taxpayer’s primary purpose, but rather the claim originated in the acquisition of the asset.

Next is Commissioner v. Idaho Power Co., 418 U.S. 1 (1974). The Idahoans wanted to depreciate construction equipment they bought to build a new facility. The Supremes said that buying and operating that equipment in building the facility was again part and parcel of the construction cost , but to the extent the Idahoans used the construction equipment for operations, they could depreciate that part.

And, finally, our old friend INDOPCO, Inc. v. Commissioner, 503 U.S. 79,(1992), a Tax Court favorite vying with Neonatology Associates as the most-cited case in Tax Court’s canned opinions. After usual deference to facts and circumstances, the Supremes held that the expenditures INDOPCO made to be acquired by a friendly fellow company, (a) benefitted INDOPCO beyond the year paid or incurred, and (b) “bear the indicia” of a capital rather than an ordinary expenditure. And deductions must be construed narrowly.

That’s not the case here, says Sixth Circuit. Getting rid of the lease is deductible, and IRS concedes that, but fights about the acquisition of the hotel.

So the origin of the claim, a la Woodward, is ABC’s desire to get out of the lease, not to buy the hotel. And while INDOPCO teaches us that deductions are to be narrowly-construed, IRS already conceded that the lease buyout would be currently deductible. And Idaho Power allows a capital item to be capitalized and depreciated in different tranches, depending upon facts and circumstances.

IRS then claims Section 167(c)(2) bars adding leasehold basis to property acquired subject to lease for depreciation purposes. But Sixth Circuit says the exact language is ambiguous: does it mean only “while the property remains subject to a lease after acquired” or does it mean “if the property was subject to a lease at the moment of acquisition, whatever happens later”?

Legislative history says the provision was enacted to prevent taxpayers from using the Section 197 quick-kick depreciation while including in basis the leasehold interest in the property. Not the case here. And “subject to” is a phrase with much judicial glossing, all of which says “ongoing”, as in “subject to a mortgage”.

So Judge Cole concludes: “Because § 167(c)(2) does not prohibit ABC from deducting the lease expense at issue, and because no decision of the Supreme Court requires us to modify our prior decision, Cleveland Allerton remains in full effect, controls the outcome of this case, and permits ABC to deduct the lease expense.” Decision, at p. 12.

Us old guys keep going on and on and on….

IRS has promulgated what is called the “Taxpayers’ Bill of Rights”, a noble document that, one devoutly wishes, will actually have results, although I beg leave to doubt it.

You can read all about it in IR-2014-72, 6/10/14, which I missed while visiting the Bayou City, wherein reside my children and grandchildren.

Some things are so much more important than taxes.

Now back to business.

I would draw my readers’, all 101 of them, attention to Right Number Five, which provides as follows:

“The Right to Appeal an IRS Decision in an Independent Forum

“Taxpayers are entitled to a fair and impartial administrative appeal of most IRS decisions, including many penalties, and have the right to receive a written response regarding the Office of Appeals’ decision. Taxpayers generally have the right to take their cases to court.” http://www.irs.gov/Taxpayer-Bill-of-Rights

While IRS admits that taxpayers now “generally” (oh, how I love that word! Keeps us all eating and putting many Huggies on a darling little person) have the right to take their cases to Court, IRS has systematically obstructed taxpayers, by misleading and confusing them.

Case in point, Yisroel Goldstein & Temi Goldstein, Docket No. 6373-14S, filed 6/13/14, from Ch J Michael B. (“Iron Mike”) Thornton.

Yis is trying, really he is, to resolve his differences with IRS. In responding to the usual IRS boilerplate you’re-too-late (108 days after SNOD) motion to dismiss, Yis says he is late, but details his “…efforts to resolve their tax matters administratively within the Internal Revenue Service (IRS) and detailed multiple attempts to submit information, explanation, and documentation. Petitioners further suggested that they should not be ‘penalized’ for the late petition when, given their prior submissions to the IRS and the merits of their substantive position, the need to instigate a court case should never have arisen.” Order, at p. 2.

Ch J Iron Mike well understands Yis’ plight: “The law is well settled, however, that once a notice of deficiency has been issued, further administrative consideration does not alter or suspend the running of the 90-day period. Even confusing correspondence, written or verbal, during the administrative process cannot override the clearly stated deadline in the statutory notice of deficiency. Such confusion is not uncommon given that the IRS frequently treats as separate processes or proceedings what taxpayers view as a single dispute. Taxpayers not infrequently have also conflated this Court with an IRS unit, but the IRS is a completely separate and independent entity from the Tax Court.” Order, at p. 2.

So, Yis, you have a right, but no one will explain this to you or tell you how and when to use it. And IRS has a license to mislead you or confuse you.

Forget rights. The law is well-settled. And it is settled wrong.

Mr. J. P. Finet, now or formerly legal editor of BNA Daily Tax Report, a periodical subsequently subsumed by the Bloomberg octopus, asked me for my views on Coffey v. Com’r, No. 11-1362, decided 12/2/11 by the Eighth Circuit, back on 12/2/11, and why anyone other than a VI practitioner should care.

See my blogpost “Somebody Does Read This Blog”, 12/4/11.

I responded thus: “So my reply to Mr. Finet’s request for ‘a sentence or two why practitioners should care’ is ‘All practitioners should care because it matters that taxpayers, and people, should know that when it’s over according to law, it’s over.’”

So now, only two-and-a-half years late, IRS has clambered onto the bandwagon (at long last), with the “Taxpayers’ Bill of Rights”, wherein Right Number Seven reads as follows:

“The Right to Finality

“Taxpayers have the right to know the maximum amount of time they have to challenge the IRS’s position as well as the maximum amount of time the IRS has to audit a particular tax year or collect a tax debt. Taxpayers have the right to know when the IRS has finished an audit.” http://www.irs.gov/Taxpayer-Bill-of-Rights

I’ll have more to say about this document in another blogpost, coming soon to a screen near you.

Nope

First year law school class in contracts, and we’re discussing the case of the stenographer’s error in taking down the price of potatoes. Scrivener’s error, so no contract, says the Court. Meeting of parties’ minds not reflected in erroneous letter (it was a long time ago, pre e-mail, texting, etc.).

Well, now Hank Black, the legal dictionarian, calls it “clerical error”, but whichever it is, that’s not going to help Adrio Michael Baur, 2014 T. C. 117, filed 6/12/14.

Adrio wants to claim that the emancipation proclamation in favor of his child, set forth in his divorce Marital Settlement Agreement, is a “scrivener’s error”, which State court retroactively removed from the judgment of divorce (after Adrio got the SNOD) but Judge Chiechi isn’t buying it.

Remember, Section 71(c)(2) makes any contingency to do with children into child support and not alimony.

“We must determine what, if any, effect we should give to that purported nunc pro tunc order. In making that determination, we have in mind that ‘the definition of alimony for Federal income tax purposes turns on a fulfillment of the statutory test [in section 71] and not on the intent of the parties to a divorce proceeding or of the court overseeing that proceeding’. Okerson v. Commissioner, 123 T.C. 258, 266 (2004). We also have in mind what we stated in Gordon v. Commissioner, 70 T.C. 525, 530 (1978):

“‘State court adjudications retroactively redesignating divorce- related payments as alimony and not child support (or vice versa) are generally disregarded for Federal income tax purposes if the order retroactively changes the rights of the parties or the legal status of the payments. An exception to this rule is made when a retroactive judgment corrects a divorce decree that mistakenly failed to reflect the true intention of the court at the time the decree was rendered. * * * [Citations omitted.]”. 2014 T. C. Memo. 117, at p. 12.

And the Marital Settlement Agreement, incorporated in the divorce judgment years ago, said Adrio and ex “freely and voluntarily entered into this Agreement of their own volition, free from any duress or coercion and with full knowledge of each and every provision contained in this Agreement and the consequences thereof. * * *.” 2014 T. C. Memo. 117, at p. 4.

Adrio, you’re stuck with it.

And because you introduced no evidence that you acted in good faith reliance, you get the substantial understatement chop.

Takeaway- Section 71(c)(2) is a boobytrap for family law practitioners. Hopefully, if we bloggers talk it up often enough, the word will get out.

No Penalty Shot

 Fifth Circuit is Judge Halpern’s nemesis; he can’t please them. Here’s the latest, courtesy of my colleague Joel E. Miller, Esq.

I was off in the Bayou City visiting the grandchildren, so I missed Joel’s presentation to the New York State Bar Association’s Coop/Condo Committee today; too bad, because Joel always has something worth hearing, and today’s gem is Whitehouse Hotel Limited Partnership; QHR Holdings – New Orleans Limited, Tax Matters Partner, No. 13-60131, decided 6/11/14.

For past history, see my blogpost “Chipping Away The Façade – Part Deux”, 10/24/12.

Now getting the remand from Fifth Circuit, Judge Halpern, with misgivings and begrudgingly, re-evaluated the worth of the Whitehousers’ façade easement of its historic hotel, and adjusted down the claimed overvaluation thereof to a mere 401%.

I’ll spare you the appraisal mixology in which Judge Halpern engaged, and Fifth Circuit’s equally begrudging acknowledgement that Judge Halpern stopped a shaved inch short of judicial insubordination in ignoring Fifth Circuit’s mandate on remand.

So the Whitehousers have a tax hit. But what about the 40% overvaluation chop with which Judge Halpern topped them off?

The Whitehousers got two appraisals before they filed the tax return at issue, and had attorneys and CPAs prepare the tax return. IRS concedes there was one valid appraisal, although IRS disagrees with the result.

“Our review of the tax court’s decision starts with the principle that ‘[w]hen an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for a taxpayer to rely on that advice.’ United States v. Boyle, 469 U.S. 241, 251 (1985). ‘Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney.’ Id. at 251. The Court held, though, that the relevant issue in that case of meeting filing deadlines was not an area in which tax experts were necessary. Id. at 251-52. Our earlier opinion cited Boyle for the tax court to consider on remand. Whitehouse Hotel, 615 F.3d at 343.” Opinion, at pp. 20-21.

Judge Southwick went on: “We conclude that the tax court imposed an excessively high standard of proof for actual reliance on the advice of competent tax professionals with respect to this statutory defense. The tax court concluded in its remand decision that ‘the record is bare of any evidence supporting’ a conclusion that Whitehouse undertook any investigation of the amount of the deduction for the conveyance of the easement and presumed that the tax professionals also did not. Whitehouse Hotel, 139 T.C. at 361. We disagree.

“Valuation of assets is a difficult task, even with the advice and counsel of accountants, consultants, and tax attorneys. It is even more complicated when, as here, the valuation is divorced from a negotiated transaction between buyer and seller. In most transactions, presumably, the final sale price is forged from competing interests. That dynamic makes the sale price a good indicator of the fair market value of a given property. Even then, that price may be altered up or down by idiosyncratic characteristics of the parties. This is not the case here. This easement was a gratuitous transfer; the PRC did not haggle over price and did not pay a final sale price.” Opinion, at pp. 21-22.

And IRS, IRS’ expert, and Judge Halpern all reached different numbers for the worth of the easement. This was a strong factor in Fifth Circuit’s decision to throw out the 40% chop.

“Obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally-prepared tax return is sufficient to show a good faith investigation as required by law. See I.R.C. § 6664(c)(3)(B). The tax court’s enforcement of the gross undervaluation penalty was clearly erroneous.” Opinion, at p. 22.

The façade may crumble, but the Whitehousers are penalty-free.

The rebate debate continues, but this time the debate hits the road in YRC Regional Transport, Inc. and Subsidiaries, f.k.a. USF Corporation and Subsidiaries, 2014 T. C. Memo. 112, filed 6/10/14.

In its USF days, YRC had an NOL, for which it requested a refund in its YRC days as a carryforward. IRS sent two refund checks for the same refund.

When IRS discovered its mistake, it hit YRC with an increased deficiency. IRS had issued a SNOD for a much lower amount, which sparked the petition here, then amended their answer to try to recoup the overpayment, even though the Section 7405 SOL had run. IRS claimed it had recalculated YRC’s deficiency; YRC claimed that IRS was trying to recoup its own error too late, and moved for summary judgment.

Judge Kerrigan gives YRC summary judgment. The erroneous IRS payment is not a rebate; a rebate arises from an IRS recalculation of tax owed, when a taxpayer pays too much. A nonrebate is an IRS error, plain and simple. And this is one.

Judge Kerrigan: “Refunds issued by the Commissioner by accident are nonrebate refunds, while rebate refunds are issued because of the taxpayer’s tax liability.” 2014 T. C. Memo. 112, at p. 7.

Tax Court has jurisdiction to consider deficiencies, as defined by Section 6211(a), that is, the difference between tax actually imposed, and tax paid, tax previously assessed or collected without assessment, plus rebates. Here, no rebate, so the only deficiency for which IRS can go after YRC is what was underpaid by YRC.

As for the erroneous double payment, as Tax Court has no jurisdiction, IRS must, in the immortal words of the Bard, “seek him i’ th’ other place yourself.” Hamlet, Act IV, Sc. 3.

No, not the Rodgers and Hammerstein 1945 Maine seaside epic that gave birth to the classic “You’ll Never Walk Alone”.

Today, however, Jeffrey Holden takes up that canzone. Who is he? Jeff’s a reluctant witness in someone else’s Tax Court case. Whose case? Why, Amazon.Com Inc., & Subsidiaries, Docket No. 31197-12, filed 6/9/14.

The internet mega-emporium is apparently embattled over something called the Project Goldcrest transaction, and Mr. Holden, a former employee of The Big A, apparently has some discoverable information thereabout, or so IRS is able to convince Judge Lauber.

IRS asked Jeff for an informal chat, but Jeff said no. IRS then sent Jeff a formal notice, and Jeff again said no. So IRS moves for an order directing Jeff to show for a deposition, attaching a written response from Jeff’s attorney saying Jeff objects.

“Rule 74(c) provides that the taking of a deposition of a nonparty witness is an extraordinary method of discovery that may be utilized when the testimony sought is relevant and not privileged and ‘cannot be obtained through informal consultation or communication.’” Order, at p. 1.

Remember Rule 74? No? See my blogpost “Don’t Suppose You Can Depose”, 12/2/13. Jeff’s testimony must be extraordinary.

Jeff claims he isn’t the sole source of the information IRS wants. But that’s only one test.

Judge Lauber: “In a case as complex as this, it will rarely be true that a single individual is the sole repository of relevant, non-privileged information. Allowing a ‘sole source’ defense could lead to an endless carousel of objections in large, complex cases where no witness would ever have to be deposed.” Order, at p. 2.

And Judge Lauber isn’t buying Jeff’s claim that he’s too busy to talk.

“The Court is sympathetic to Mr. Holden’s busy schedule, but that alone cannot be a justification for preventing respondent from obtaining relevant, discoverable information; the other 11 witnesses to be deposed likely have busy schedules too. Acknowledging Mr. Holden’s busy schedule, respondent has promised to ‘make every effort to schedule Mr. Holden’s deposition at a place and time that will accommodate his other obligations.’ We will hold respondent to this promise.” Order, at p. 2.

So, though busy Jeff may not have walked alone through Project Goldcrest transaction, he’s got to tell IRS all about it.

Freedom is not free, and neither is US residency. That’s the lesson for Clifford A. Abrahamsen and Sole K. Abrahamsen, in 142 T. C. 22, filed 6/9/14, as taught by Judge Lauber.

It’s Sole’s sole responsibility, as she is a Finnish citizen who came to the USA to work for the Finnish UN Mission. She left the UN Mission to work for the New York branch of a Finnish bank, then went back to the Finnish UN Mission. When first with the Mission and for a time at the bank, she held nonimmigrant US visas. But while at the bank, she decided to apply for permanent US residence.

“As a condition of obtaining that status, she executed U.S. Citizenship and Immigration Services (USCIS) Form I-508, Waiver of Rights, Privileges, Exemptions and Immunities. By signing Form I-508, Ms. Abrahamsen acknowledged that she was then employed in an occupation under which she had nonimmigrant status and declared that she desired ‘to acquire and/or retain the status of an alien lawfully admitted for permanent residence.’ She affirmed by signing this form that she agreed to ‘waive all rights, privileges, exemptions and immunities which would otherwise accrue to [her] under any law or executive order by reason of [her] occupational status.’ 142 T. C. 22, at p. 4.

You can guess the rest. The UN never listed Sole as a diplomat, and neither did the US Mission to the UN. Not deterred, Sole never bothered to report her income from the Mission for six years, claiming Section 893.

But Section 893 only applies to noncitizens of the USA. And in any case, the benefits of Section 893 are waivable, and IRS produces the waiver Sole signed.

For more about Section 893, see my blogpost “IRS Justified”, 3/19/12.

Sole’s lawyers try the “I didn’t know” tactic, which is the usual dead loser. “Petitioners claim that English is Ms. Abrahamsen’s second language; that she signed the waiver more than 20 years ago; that Form I-508 was difficult to understand; and that she did not appreciate the long-term effects of signing the waiver. We expect that many foreign nationals seeking permanent resident status in the United States could advance similar arguments. If such arguments were sufficient to nullify the Forms I-508 they signed, the carefully constructed waiver procedure set forth in the regulations would become the exception rather than the rule.

“More importantly, petitioners cite no statute or judicial precedent to support their assertion that we can ignore a validly executed waiver.” 142 T. C. 22, at pp. 8-9.

The US-Finland tax treaty doesn’t help, because it expressly exempts from its scope residents of the US.

And the Vienna Convention on Diplomatic Relations doesn’t help, because Sole was never listed as a diplomat either by the UN or the US Mission. Nor does the International Organizations Immunity Act, again because Sole never had diplomatic status. And earning income in the US is not a diplomatic function.

Now this opinion is the result of cross-motions for summary judgment. The good-faith exemption from penalties is a fact question: what did Sole tell her preparers, if any, and what were the qualifications; or what did she do herself, to ascertain her correct liabilities?

So that has to be tried.

Don’t Step In It

IRS gets the word from Judge Kroupa in Docket No. 5576-12, filed 6/6/14, Eaton Corporation and Subsidiaries. Remember Eaton Corporation? Or its breaker subsidiaries? No? Then see my blogpost “Advance and Retreat”, 6/25/13, the story of Eaton’s revoked APAs and IRS’ moat around said revocations.

Now maybe we’ll have a trial, but IRS wants the trial bifurcated. First, says IRS, let’s see if IRS was arbitrary, capricious or manifestly disregard the law by revoking the Advance Pricing Agreements it made with Eaton. If IRS is sustained, all the rest will settle.

And if the other issues don’t settle, we can try them then. The proofs are different, so we can save time by trying arbitrary-and-capricious first and the arithmetic of the deficiencies later.

Judge Kroupa has discretion. And Eaton wants the whole enchilada tried at once.

IRS didn’t convince Judge Kroupa. And it’s basic Tax Court policy to try everything at once, to save time and effort. This is the sixty-buck-access-to-justice, remember, even though here the numbers run into hundreds of millions.

There are two other orders in Eaton from Judge Kroupa today. One has to do with summary judgment, and Judge Kroupa is sufficiently annoyed with all the summarizing, that she tells both Eaton and IRS no more without “good cause shown”. The other is a discovery jump-ball with interlocutory appeal thrown in, and is of interest only to the hypertechnically-inclined.

Takeaway: Unless you have a really good reason, don’t step in the bifurcation.

If the trustee of your IRA account doesn’t want to do a deal, don’t get creative: just find another trustee. That’s the moral Judge Vasquez has for Guy M. Dabney and Ann V. Dabney in 2014 T. C. Memo. 108, filed 6/5/14.

Guy had an IRA, and he moved it to Charles Schwab, who advises its clients to “Talk to us anytime”. Guy did just that, when he spotted a land deal with a good chance for a big scoop.

At first Guy’s accountant thought that IRAs couldn’t invest in land, but Guy did the research (with which Judge Vasquez agrees), convinces his accountant, and tells Schwab to buy the land.

Schwab says no, Schwab doesn’t do investments in land, its trustee agreements say it does financial instruments only, and thereby hangs the tale.

Guy gets creative, orders a cash withdrawal from his IRA, and checks the Code 1 box on the withdrawal slip (“early withdrawal, no known exception”). This, of course, gets sent to the IRS’ fish-flopping-in-the-water department.

In the meantime, Guy has the cash wired to buy the land, and wants title in himself and Schwab as trustees, but of course the escrow company puts title in Guy himself.

Guy ultimately unloads the land at a 25% profit, but IRS unloads on Guy for substantial understatement and mucho tax plus the 10% early withdrawal chop.

Judge Vasquez goes off on the powers of a trustee, and ultimately the trust instrument itself governs. If the trustee won’t do something, and says so in writing, then game over. The trustee isn’t the trustee for that purpose, and even if title had been placed as Guy directed (or if the escrow company’s scrivener’s error affidavit was acceptable), it wouldn’t help.

As far as the law is concerned, Guy bought the land himself with the cash he took from his IRA. The IRA trustee had nothing to do with it.

Judge Vasquez himself says that if Guy had done a trustee-to-trustee out of Schwab and into a trustee that did agree to hold land, and that trustee bought the land (and, I suppose, even if the escrow company made a mistake but later corrected it), the deal would have been good.

Takeaway: read the trustee agreement; and don’t get creative.