Just when my intrepid band of readers thought they had finished the slog through The Great Uncoupling of understatement and deficiency, more particularly bounded and described in my blogpost “The Rebate Debate – Part Deux”, 11/18/13, comes now Judge Gale, who upsets a stipulated decision document because of the fallout from Rand v. Com’r., 141 T. C. 12, filed 11/18/13.

You can read all about it in Rivka Faecher, Docket No. 16049-12, filed 11/22/13.

Riv, like Yitz and Shul in the Rand case, got aggressive with the Additional Child Tax Credit (also known as a rebate) for a couple of years, and folded when IRS called her out.

So she and IRS stipulated to entry of decision (that’s what most lawyers would call a “judgment”, stating who owes who what), with understatement penalties computed pre-Rand, that is, with understatements based on the rebates taking Riv’s deficiencies below zero, so the 20% chop was applied to the negative numbers.

Judge Gale says no, it’s true y’all did your numbers pre-Rand, but post-Rand they don’t fly, and the understatements and penalties associated therewith should all be zero.

So he tells IRS: “Because the stipulated decision was executed by the parties before the Court issued its opinion in Rand, the Court is concerned that imposition of penalties in this case may not be appropriate. If the understatements for the years in issue were computed in accordance with Rand, they–and the resulting accuracy-related penalties–would all be $0.” Order, at p. 2.

Under Section 7491(c), IRS has the burden of coming forward with evidence to support the imposition of the penalty.

So IRS can either concede the understatement penalties and treat the stipulated decision document as settling everything else, or else can show cause why IRS has come forward with evidence sufficient to impose the penalties (notwithstanding they just lost the Rand case).

 Nothing exciting out of Tax Court today, 11/21, but there is one useful item for the lawyers out there.

If you’re looking to craft a heavy-duty motion for a protective order, cast your eyes over Judge Lauber’s eleven-page magnum opus in Amazon.Com, Inc.  & Subsidiaries, Docket No. 31197-12, filed 11/21/13.

As one would expect, Amazon.Com, Inc. has the first team on the field for this one. I count eight lawyers on the roster so far, doubtless with the meters merrily ticking away.

I’m sure my wife’s Amazon Prime account is safe.

Just signing a contract isn’t enough. That’s Judge Marvel’s word to VECO Corporation and Subsidiaries, 141 T. C. 14, filed 11/20/13.

VECO and its bushelbasketful of subsidiaries echo the Beach Boys’ 1964 hit: they get around. From Wyoming to Alaska to Colorado to Washington, VECO was busy with “oil and gas field services, newspaper publishing, manufacturing, construction, equipment rental, wholesale sales, leasing, and engineering.” 141 T. C. 14, at p. 5, and entered into numerous contracts in furtherance of all the foregoing, as the expensive lawyers say.

VECO’s tax problem? They want to shunt the tax incidents of their 2006 contracting into 2005. So VECO attaches to their 2005 return Form 3115, Application for Change in Accounting Method, for their 2005 tax year, requesting an accounting method change pursuant to Rev. Proc. 2005-9, 2005-1 C.B. 303.

Rev. Proc. 2005-9 provides an automatic change of accounting method for the second tax year following 2003, which just happens to be 2005. Except IRS says no.

VECO of course is an accrual basis taxpayer. So it’s “all events”, reasonably ascertainable amount, and economic performance.

Just signing a contract isn’t enough, though. Judge Marvel: “The execution of a contract contemplating payment, without more, is not an event that fixes the payor’s liability. See Spencer, White & Prentis v. Commissioner, 144 F.2d 45, 47 (2d Cir. 1944) (‘It is well settled that deductions may only be taken for the year in which the taxpayer’s liability to pay becomes definite and certain, even though the transactions (such as the contract in the present case) which occasioned the liability, may have taken place in an earlier year.’). In particular, where a contract ‘contains mutually dependent promises, liability under it is contingent upon performance or tendered performance’, and is not fixed by merely entering into the contract. Levin v. Commissioner, 219 F.2d 588, 589 (3d Cir. 1955), aff’g 21 T.C. 996 (1954); see also Gulf Oil Corp. v. Commissioner, 914 F.2d 396, 409 (3d Cir. 1990) (‘Unconditional liability under an executory contract is not created until at least one party performs.’), aff’g 86 T.C. 115 (1986).” 141 T. C. 14, at p. 37.

In simple English, an agreement that you’ll do this if I do that doesn’t establish liability for accrual purposes unless one of us does something.

And the three-and-a-half month test doesn’t help VECO. Forgot the three-and-a half-month test? See my blogpost “Drill, Baby, Drill”, 1/12/12. No way could the contemplated performances be completed within three-and-a-half months after the end of VECO’s tax year.

Finally, VECO wants the recurring item treatment. Now watch this closely:

“Under the recurring item exception, a taxpayer may treat an item as incurred during any taxable year if:

(i)            the all events test with respect to such item is met during such taxable year (determined without regard to * * * [section 461(h)(1)]),

(ii)            economic performance with respect to such item occurs within the shorter of–

(I)            a reasonable period after the close of such taxable year, or

(II)            8 1/2 months after the close of such taxable year,

(iii)            such item is recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in which the requirements of clause (i) are met, and

(iv) either–

(I)            such item is not a material item, or

(II)            the accrual of such item in the taxable year in which the requirements of clause (i) are met results in a more proper match against income than accruing such item in the taxable year in which economic performance occurs.” 141 T. C. 14, at p. 53.

You can accrue a recurring item. But VECO can’t, because they flunk economic performance on a lot of their deductions, and materiality, as determined under GAAP, goes against them.

Here’s FASB’s take: materiality is “ ‘[t]he magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.’ Statement of Financial Accounting Concepts No. 2, “Qualitative Characteristics of Accounting Information” (1980) (SFAC No. 2).” 141 T. C. 14, at p. 55, footnote 53.

Taishoff’s Rule of Footnotes: when there are almost as many footnotes as pages, or more footnotes than pages, someone is in trouble.

Of course, everything is material. VECO was inconsistent in reporting for financial and for tax purposes, and that makes whatever it is material, regardless of size.

I think I deserve at least a small kudo for not referring to Otis Blackwell’s fifth best song of 1956 and 92nd on the all-time list.

The latest issue of our State’s Bar Association Journal carried a story with the fetching title “Jackson Estate Says, ‘Beat It, IRS’.”

I fired off a letter to the editor, but my e-mails kept bouncing because the e-address given is inactive.

So I posted this to the Association’s LinkedIn page. And if that doesn’t give it sufficient publicity, here it is again.

Sir, Robert W. Wood, Esq., is rather more sanguine than I about the outcome in Estate of Michael J. Jackson, Deceased, John G. Branca, Co-Executor and John McClain, Co-Executor v. Com’r., Docket No. 017152-13, in his article “Jackson Estate Says ‘Beat It, IRS’.”, Nov/Dec 2013.

While I haven’t any hard statistical evidence to give independent support to this conclusion, I must agree with James Edward Maule, who stated the case almost 15 years ago in Instant Replay, Weak Teams, and Disputed Calls: An Empirical Study of Alleged Tax Court Judge Bias, 66 Tenn. L. Rev. 351, 353, 401 (1999). According to Mr. Maule, the IRS rarely loses in Tax Court, opinions are rarely appealed (in Tax Court, an opinion states the law, or what non-Tax Court practitioners would call a decision; a Tax Court decision fixes the amount of tax due, if any, or what the non-Tax Court practitioner would call a judgment), and even if appealed, are rarely overturned in the Circuit Courts of Appeal.

Few courts see more valuation cases than Tax Court. And the sums involved run into the hundreds of millions. See, for example, Eaton Corporation (transfer pricing; arms’-length valuation), 140 T. C. 18, 6/25/13 ($368 million, plus interest); and the plethora of façade easement cases (e.g., Dunlap; Scheidelman; Gorra). Although Second Circuit did overturn Scheidelman I, taxpayer lost in Scheidelman II.

And of course a case that settled, but excited considerable interest in the art world, Estate of Ileana Sonnabend, Docket No. 649-12, which settled a $65 million deficiency for $1.3 million, the case of the prohibited eagle. There the issue for trial would have been the worth of a work of art that could not be sold, bartered or exchanged without incurring criminal penalties.

Moreover, Tax Court is no stranger to valuing a person’s image. See Retief Goosen, 137 T. C. 1, 6/9/11; cf. Sergio Garcia, 140 T. C. 6, filed 3/14/13. Garcia is interesting for its contrast with Goosen, a “global icon” as contrasted with a “brand image”.

I will await the outcome of Jackson with interest, but much less certainty than Mr. Woods’ article suggests.

The cases cited can all be found on the Tax Court website, www.ustaxcourt.gov. Use either the link for Opinion Search or Docket Search. Tax Court’s website is user-friendly.

But while it’s still legal, you might as well tax it.  New York State, which at one time billed itself as The State That Has Everything, certainly has taxes.

And echoing King George III, specifically 5 George III, c. 12, 1765, New York State has a stamp tax, this one on cigarettes. Each package of the weed must bear the colophon of the Empire State, thereby verifying that the contents have been duly subjected thereto.

Comes now City Line Candy & Tobacco Corp., 141 T. C. 13, filed 11/19/13, a stamper. City Line buys the stamps from the State (or from New York City), buys packages of cigarettes in enormous bulk, affixes the stamps to the packages, and sells them to subjobbers, licensed retailers and vending machine operators.

Of course, the price paid by the subjobbers and others includes the stamp tax. And while the consumer ultimately pays the price, the stamper is in some sense responsible for the tax.

City Line is a licensed reseller, and thereby hangs the tale. City Line wants to be a small reseller, so as to avail itself of the Section 263A(b)(2)(B) exemption from the Section 263A UNICAP rules. To do so, City Line must show gross receipts less than $10 million.

But should the stamp tax amounts included in the price City Line receives be part of gross proceeds?

It falls to Judge Marvel to smoke out (sorry guys) the answer. And it doesn’t help City Line; they must capitalize the cost of the stamps, and include any leftovers in year-end inventory. And that kicks them over the $10 million barrier.

City Line’s problem: “For all relevant years petitioner used the accrual method of accounting for income and expenses and the first-in, first-out method of accounting for inventory. Petitioner did not introduce its financial statements for each of the relevant years into evidence. However, the profit and loss statement for 2004 that is in the record confirms that for financial statement purposes petitioner calculated its gross receipts from cigarette sales by totaling the gross sale prices of cigarettes sold without any reduction for the cost of the cigarette tax stamps that was included in the sale prices.” 141 T. C. 13, at pp. 5-6.

And of course, one of City Line’s witnesses drives the nail in even deeper: “Mr. Kun Sang Ruy, one of petitioner’s shareholders, testified that the amount reported as gross receipts on its tax returns reflected a ‘net’ amount.” 141 T. C. 13, at pp. 18-19.

There’s much accounting byplay, involving storage and handling costs as against administrative costs, and cost absorption ratio. And discussion about the deductibility of the stamps, but that’s not gross proceeds, that’s net taxable income.

Bottom line: “For tax and financial accounting purposes a taxpayer must first calculate total sales revenue determined in accordance with its method of accounting. For financial accounting purposes petitioner did just that. For income tax reporting purposes, however, petitioner reduced its total gross receipts from cigarette sales by the cost of the cigarette tax stamps it purchased during the taxable year to arrive at a gross receipts figure that was substantially lower than the figure used for financial accounting purposes.” 141 T. C. 13, at p. 19.

You gotta tell the same story. Or your case goes up in smoke (sorry, guys).

And Maybe Woodshedding Your Client

I’ve often discoursed about the need to woodshed your experts: sweat them, find the sweet spot in your case that they must prove, and learn as much of their specialities as you can in the limited time you have.

But what happens when your expert refuses the jump?

That’s the problem in Estate of Diane Tanenblatt, Deceased, Roy L. Greenbaum, Personal Representative, 2013 T. C. Memo. 263, filed 11/18/13. And Judge Halpern isn’t sympathetic.

The Late Diane was (or maybe not) a member of a NY LLC that owned a fully-rented commercial building in the Ladies’ Mile section of Manhattan. But Diane’s stake was a distinct minority, and she couldn’t sell without all the other members’ consents. So Roy values her piece at $1.78 million on the 706, but gets audited and is unhappy with the result.

IRS’ expert comes in enough higher to give the estate a $309K deficiency. The issue of course is the discount for minority and for lack of transferability.

Roy petitions and attaches to his petition a new appraisal (called Tindall), to which he wants IRS to stipulate. IRS only agrees that something is attached to the petition, but they can’t say whether Roy obtained it, or anything else about it.

“Petitioner’s path for attempting to introduce the Tindall appraisal into evidence as expert testimony is, to say the least, unusual. Generally, a party obtains the testimony of an expert witness by calling that witness to testify. See Rule 143(g)(1). Pursuant to that Rule, the expert witness must prepare a written report, which is marked as an exhibit and, after having been identified by the witness and adopted by him, received into evidence as his direct testimony unless the Court determines that the witness is not qualified as an expert. The Rule further provides that, not less than 30 days before the call of the trial calendar on which a case appears, a party calling an expert witness shall serve on each other party and submit to the Court a copy of the expert’s report. Finally, the Rule also provides that, generally, we will exclude an expert witness’ testimony altogether for failure to comply with the Rule. Those requirements are echoed in our standing pretrial order, which was served on petitioner.” 2013 T.C. Memo. 263, at pp. 10-11.

Sounds rather like Sir Paul McCartney’s 1969 hit “She Came In Through the Bathroom Window”, rather than through the front door.

So why not follow the Rule?

Well, counsel had a good reason, responding to IRS’ motion to preclude Tindall: “Petitioner had filed no response to respondent’s motion in limine, and, at the hearing, in response to the Court’s question as to whether petitioner was just relying on his own motions (with respect to stipulating the Tindall appraisal into evidence), petitioner’s counsel candidly responded: ‘Probably. Your honor, because right now my client’s in a fee dispute with the appraiser, so right now I cannot get the appraiser to come in and testify.’ Apparently, counsel’s time is less dear than was Dr. Tindall’s.” 2013 T. C. Memo. 263, at p. 11.

Time to woodshed the client? With $309K on the table, might be well to consider whether Tindall might not be worth the extra.

Because Judge Halpern is the gatekeeper, charged with letting in evidence per the rules, both the Tax Court rules and the FRE.

“Petitioner did not call Dr. Tindall as a witness but asks us to rely on her report (which, under our Rules, would serve as her direct testimony) as her expert opinion. Petitioner has neither qualified Dr. Tindall as an expert entitled pursuant to rule 702 of the Federal Rules of Evidence to give her opinion on technical matters nor has he satisfied our procedural rules for expert testimony, found in Rule 143(g) and in our standing pretrial order. In other words, petitioner has failed to satisfy the preconditions for our receiving Dr. Tindall’s opinion into evidence. Because her report (i.e., the Tindall appraisal) is not in evidence, we may not consider her opinion.” 2013 T. C. Memo. 263, at p. 19-20.

There’s a lot more about IRS’ expert’s appraisal, but the game is over when Tindall refuses the jump.

Those of my readers (those few, those happy few, that band of brothers and sisters, to paraphrase the Bard of Avon) who slogged their way through my blogpost “The Rebate Debate”,  9/19/13, and even the more turgid prose of Judge Ruwe in Glenn Lee Snow, 141 T. C. 6, filed 9/19/13, and still have an appetite for decoding what is an “underpayment” for the 20% Section 6662(a) chop, are invited to join Judge Buch in the uncoupling of “deficiency” from “underpayment”, as wrought by the 1989 Omnibus Budget Reconciliation Act. The uncoupling and recoupling takes place in Yitzchok D. Rand and Shulamis Klugman, 141 T. C. 12, filed 11/18/13.

Here goes: “Although they are linked by history, the fact remains that in 1989 Congress uncoupled these terms. And although identical words are presumed to have the same meaning, the presumption ‘is not rigid’. United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 213 (2001) (quoting Atl. Cleaners & Dyers, 286 U.S. at 433). But here, Congress expressly indicated that uncoupling these terms was not intended to remove their definitional nexus. Despite detaching the definition of an underpayment from the definition of a deficiency, Congress informed us that ‘the bill provides a standard definition of underpayment for all of the accuracy-related penalties. This standard definition is intended to simplify and coordinate the definitions in present law; it is not intended to be substantively different from present law.’ HR. Rept. No. 101-247, at 1394 (1989), 1989 U.S.C.C.A.N. 1906, 2864. But see H.R. Conf. Rept. No. 101-386, at 654 (1989), 1989 U.S.C.C.A.N. 3018, 3257. Given that sections 6211(a)(1)(A) and 6664(a)(1)(A) use the same phrase and that the two provisions are contextually and historically related, we turn to section 6211(a)(1)(A) to assist us in interpreting the provision before us.” 141 T. C.12,  at p. 18.

Yitz and Shul claimed three refundables they admit they weren’t entitled to, leaving a $7K deficiency. IRS claims the underpayment was the refund Yitz and Shul got they weren’t entitled to; Yitz and Shul claim that the underpayment was the $144 of tax they would have owed if they hadn’t claimed the recovery rebate, the additional child, and the earned income credits. But the Cardozo Tax Clinic, amicus curiae, says the number is zero, because an underpayment can’t be less than zero.

Time for statutory interpretation. The Section 6664 regulations don’t speak to the credits Yitz and Shul took, they speak about withholding.

So Judge Buch engages in some fancy footwork: “Because the Secretary has not promulgated a regulation addressing how the refundable credits at issue here should be taken into account, we need not address whether the statute leaves room for agency interpretation. It follows that we are also not resolving the question of whether the Secretary may promulgate a regulation that is inconsistent with this Opinion. And the mere fact that we devote these pages to interpreting the statute does not, by implication, mean that the statute is ambiguous. Whether a statute is ambiguous is determined not only from the language of the statute being considered, but also from the ‘language and design of the statute as a whole.’ See, e.g., K Mart Corp. v. Cartier, Inc., 486 U.S. 281, 291 (1988). Thus, in looking beyond the language of section 6664(a)(1)(A) as part of our analysis, we are not answering the question of whether the statute is ambiguous. We are simply interpreting the statute. And to do so, we turn to principles of statutory construction.” 141 T. C. 12, at p. 15 (Footnote omitted).

And while the refundables contribute to the deficiency, they don’t contribute to the underpayment, at least to take the underpayment below zero. And as for IRS’s argument that Judge Buch is letting Yitz and Shul off the hook, the rule of lenity, an ancient canon, says that penalties are strictly construed in favor of the penalized. And if IRS wanted to nail Yitz and Shul, they should have used Section 6676 excessive refund claim 20% chop to whack Yitz and Shul.

The Cardozo boys win one.

Deputy Assistant Secretary for International Tax Affairs Robert B. Stack has announced that France signed aboard with FATCA with a Model 1 IGA on November 14. Thus, France joins Denmark, Germany, Ireland, Mexico, Norway, Spain and the UK in the Model 1 bracket, with Japan and Switzerland in the Model 2 category.

That’s nice, but where are the Caymans, the Bahamas, Liechtenstein, the Netherlands and Cyprus?

Ch J Thornton is echoing Neil Diamond’s 1972 hit in Beata Kulish, Docket No. 13240-13S, filed 11/15/13.

It’s a run-of-the-papermill order. Beata filed a paper Amendment to Petition, but the eagle eyes at 400 Second Street, NW, noticed that the paper did not bear Beata’s original autograph. There are dozens of such orders coming out of Tax Court every day, telling the non-signers to sign on the dotted line.

But Ch J Thornton is unusually specific: “An Amendment to Petition, bearing an original signature (preferably in blue ink), must be submitted to the Court in paper form.” Order, at p. 1. (Emphasis added).

We all know that Rule 26(b)(1) prohibits e-filing of certain documents, as listed on the Tax Court website e-filing instructions link. And on page 25 of the e-filing instructions, Amendments to Petitions get a bold-faced “No”.

So it has to be paper; and make sure when the petitioner signs, they use blue ink.

And at that point, even so obliging a jurist as Judge David Gustafson (see my blogpost “We’ll Come to You”, 9/18/12) loses patience and delivers an off-the-bench designated hitter to Henry J. Lazniarz & Gina M. Lazniarz, Docket No. 31002-09, filed 11/14/13.

Henry J. is a real estatenik with a somewhat lackadaisical system of accounting for his business expenses. Henry J. had a trial last year, represented by his real estate development attorney (Lawyer No. 1), who put in minimal evidence. Henry J. saw that the trial did not go well, so he went to the bullpen.

Judge Gustafson: “New counsel for petitioner entered the case after the trial, filed petitioners’ post-trial brief, and moved for a new trial, arguing that ‘little evidence was adduced at trial. …the Court granted that motion on the grounds that petitioners’ prior counsel had not represented them adequately.” Transcript of opinion, at p. 4.

Judge Gustafson tells the parties “…the trial record would be made anew at the second trial, and that the parties should be careful to offer into evidence at the second trial all the evidence on which they intended to rely, whether or not it had been offered or received into evidence at the first trial.” Transcript of opinion, at pp. 5-6.

Judge Gustafson lets in whatever was stipulated in Trial No. 1, based on Rule 91(c), and asks what else Henry J.’s new lawyer wants. He puts in one carbon copy of a check and a summary of evidence (per FRE 1006), and tries to get in a billing summary prepared for Trial No. 2 by Lawyer No. 1, who doesn’t testify, so the billing summary gets tossed as hearsay.

Henry J.’s accountant does testify, but all he says is that he assumed everything he was told was authentic and he tried to allocate whatever was deductible.

You can read Judge Gustafson’s discussion of Henry J.’s testimony; I need not paraphrase.

Finally, the Obliging Judge admonishes Henry J. and Lawyer No. 2: “Thus, for most of the disputed deductions, no detailed testimony was given to corroborate the substantiating documents or to connect them to the business activity. When both parties had rested at the conclusion of trial, the Court pointed out to petitioner that he had not testified on most of the deductions, and petitioners’ counsel answered that petitioners had given the evidence that could be presented in the time available. Since it was late in the day, the Court asked whether petitioners wished to resume trial the next day and put on additional evidence, but they declined. Thus, although the petitioners were given a second trial, and although they were warned at that second trial that their proof might be lacking, they failed to put on evidence sufficient to carry their burden of proof.” Transcript of opinion, at p. 11.

Rule 155 beancount to follow. With the five-and-ten penalty.

There’s a limit even to the most obliging judge.