It’s been near enough nine (count ’em, nine) years since I last discoursed on this major disconnect between USDC (and most State courts) and US Tax Court practice. I’ve come back for the benefit of those who have joined since we last called at this port.

Depositions of parties are routine in most courts; the forms for FRCP 27 motions or State court equivalent are at the top of every litigator’s toolchest.

Not so at The Glasshouse on Second Street, NW. Just ask IRS’ counsel in Michael Davis & Amy L. Davis, et al., Docket No. 14870-20, filed 7/7/23. Here, depositions are “an extraordinary method of discovery that can only be taken pursuant to an order from the Court. These depositions are available only where a party or nonparty witness can give testimony that is discoverable within the meaning of Rule 70(b) and where such testimony practicably cannot be obtained through informal consultation or communication under Rule 70(a)(1), interrogatories under Rule 71, requests for production of documents under Rule 72, or consensual depositions under Rule 74(b). The decision to require an individual to submit to a nonconsensual discovery deposition is a matter that is solely within the discretion of the presiding judge. In addition to the essential criteria that the moving party must show under Rule 74(c), the Court weighs various factors to determine whether a particular case warrants an extraordinary discovery method.” Order, at p. 3. (Citation omitted).

And the Factors Three are: 1) Whether the movant has established a specific and compelling basis for the deposition; (2) Whether the movant intends the deposition to serve as more than substitute for cross-examination at trial; and (3) Whether the movant has had prior opportunities to obtain the desired information or could obtain it through other means or from another source.

Judge Christian N. (“Speedy”) Weiler flunks IRS on all three.

First, IRS hasn’t shown they can’t get the information they seek from a less invasive approach. They wanted to sit Mike down for eight hours to bukh about “transactional details of this case, the knowledge and belief of Messrs. Davis and [Partner], and their reasonable cause and good faith, including any reliance on third parties.” Order, at p. 4. (Name omitted). Judge Speedy Weiler says they haven’t shown they can’t get this otherwise.

Second, IRS hasn’t shown that the deposition would do more than set up cross on the trial.

Finally, Mike and Partner have declined an informal meet-up, but claim they’ll answer written interrogs, and maybe will do a face-to-face if they can agree on scope and ground rules. Judge Speedy Weiler is willing to wait and see.

And IRS can always try again, later.

Did I mention this is another Dixieland Boondockery? No wonder IRS has gone full-court-press.

Even when you have all of them, you still need to show who did what and have some notion of what time they spent doing it. Unhappily, Dennis Lincoln and Julia Lincoln, T. C. Memo. 2023-84, filed 7/6/23, didn’t even have the first three (the Trio Grande of the Section 41 Research Credit pre-TCJA) in most of the nineteen (count ’em, nineteen, and Judge Mega definitely has) projects for which Dennis and Julia claim the passthrough credit from the family Sub S.

One thing these Section 41s are good for: they’ll tell you more about a trade, business, or industry than you’d ever want to know. Judge Nega has written a book about removing Volatile Organic Compounds from the air. I thought those only had to do with wine, like certain esters. But what did I know? This business runs from 3M Post-It Notes to hamburger buns.

While you can Cohan a number when you can show someone did something that satisfied the Trio Grande, it has to be more than a de minimis activity like sending an e-mail. “The record contains an email from Mr. Betz to a Maxon representative asking about how to meet Celanese’s cold temperature specifications in designing the gas train. We further find that Mr. Betz’s email activity was an investigative activity within the meaning of the section 174 regulations. See Treas. Reg. § 1.174-2(a)(1). However, allocating a de minimis, estimated amount of wages to Mr. Betz’s email activity, pursuant to the Cohan rule, would be futile; we alternatively hold that Mr. Betz’s email activity was not part of a structured process of experimentation and thus fails to clear the higher bar of section 41(d)(1)(C).” T. C. 2023-84, at pp. 89-90. (Citations omitted).

And you have to show who did what, even if you don’t have timesheets or logs.

Organizational memorybanks play a role. A lot of the experimentation was done in years prior to years at issue. The Sub S had years of experience.

Quality control testing doesn’t count. And repairs and maintenance of new equipment doesn’t count, either.

Worse, five of the contracts the Sub S signed reserved to the customer all rights in whatever the Sub S produced. Thus, the contracts put the “fun” in “funded”, that is, research paid for by the customer. Three were not funded, but as no Qualified Research Expenditures were made in any of them, it doesn’t help.

Inexplicably, although the Sub S hired a high-priced consultant to scope out and compute their Section 41s, this is what they had to say about the Section 6662a negligence and five-and-ten understatement chops: “In posttrial briefing, petitioners made the single statement, as a proposed finding of fact, that they ‘are not liable for penalties under section 6662(a),’ with a supporting citation of the ‘Entire Record.’ Petitioners made no other statement or argument in their posttrial briefing with respect to their liability for accuracy-related penalties; nor did petitioners argue on brief that they had reasonable cause and acted in good faith with respect to any underpayment.” T. C. Memo. 2023-84, at pp. 112-113.

Judge Nega remarks that a skeletal assertion does not preserve a claim. Anyway, Judge Nega says he wouldn’t have bought reliance on the consultant even if they tried it, T. C. Memo. 2023-84, at p. 113, footnote 53.

Taishoff says maybe not, but why not worth a try?  Especially where, as here, the chops are substantial.

Ex-Ch J L. Paige (“Iron Fist”) Marvel wields the sculptor’s chisel, as she sculpts a Rule 104(c)(2) sanctions order preventing Cindat Manhattan Hotel Portfolio LLC, Docket No. 20935-20, filed 7/6/23 from putting in some documents they failed to produce as ordered.

Of course, the terms of the order are extensively fact-driven, so I’ll skip a lot of them. Briefly, IRS got a third document demand approved, but Cindat came up short.

Cindat had been dilatory leading up to IRS’ motion for sanctions, and hadn’t objected to the scope of the demand (which included such items as “all documents describing how petitioner qualifies as a real property trade or business under IRC § 163(j) and related Regulations,” Order, at p. 4). I should have thought that was worthy of at least an “overbroad” myself, although Judge Marvel says it “initially appears narrow, specifies that the request includes documents describing ‘petitioner’s day-to-day operations with respect to such real property.’” (Idem, as my expensive colleagues would say).

Howbeit, a voluminous response to such a demand isn’t sanctionable as an attempt to bury one’s opponent with paper (or electrons).

“Although we take issue with some of petitioner’s conduct in discovery, we are mindful that we should chart a course that does not result in undue prejudice to petitioner after accounting for the prejudice to respondent and that is consistent with the just, speedy, and inexpensive determination of this case. Cf. Rule 1(d). Rule 104(c)(2) permits us, upon a party’s failure to comply with an order of the Court with respect to Rule 72, to ‘prohibit[] such party from introducing designated matters in evidence.’ We think that it is appropriate to restrict petitioner’s ability to introduce into evidence documents and materials that would have been responsive to paragraphs 23, 33–38, and 40–41 of respondent’s third request for production of documents that have not already been submitted to respondent as of the date of this Order. Petitioner is not entitled to benefit from the late fulfillment of its discovery obligations by choosing which of its late-discovered documents to introduce into evidence, especially since it already had adequate time to undertake discovery.” Order, at p. 5. (Citations omitted).

Note also that during the period within which Cindat was to comply, they changed attorneys, and the incoming attorneys seemed to onboard and work fast. The outgoing are told in a separate order under even date to comply with Rule 24, with which they have not.

Takeaways: (1) Consider change of counsel can soften sanctions, if new crew jump to it.

(2) Maybe not objecting to overbroad demands but using them as cover to do what otherwise would be sanctionable as a document dump.

No, United States Tax Court is not joining in Bob Hilliard’s and Lee Pockriss’ 1959 hit or its account of Fred’s backseat activities. Rather, effective today, all parties in consolidated cases can “electronically file documents simultaneously in all of the consolidated cases.” Check out the latest DAWSON release notes or the DAWSON User Guides for further particulars.

Unhappily, and for no apparent reason, “Entries of Appearance for petitioner representatives and Decisions must still be filed in each case separately.”

DAWSON staggers into the last decade of the Twentieth Century, if not quite the third decade of the Twenty-First.

This date being a national holiday in celebration of independence, US Tax Court is closed. So am I.

As it was formerly, and may still be, the custom for various orators to expound at length on this date, delivering one or the other (or maybe both), I unequivocally state I shall deliver neither.

At least, not here.

Over Tiered Partnerships

Judge Joseph Nega notes the demise of TEFRA in a footnote, but if ever the Bard got it right, TEFRA proves that “the evil men do lives after them.” Just ask Phillips Family, LP, David Phillips, Tax Matters Partner, Docket No. 20369-22, filed 7/3/23.

The Philippians got not an epistle, but two (count ’em, two) FPAAs, dealing with their distributive shares from a partnership in which the Philippians were a partner. I needn’t remind my readers that these tiered partnerships (or box-checked LLCs) were the delivery system of choice for the dodgefloggers like Rogers and Haber. I’m not saying the Philippians are dodgers because I don’t know, and Judge Nega doesn’t go into details.

All Judge Nega has to do is grant IRS’ motion to dismiss for want of jurisdiction.

“If the partnership items of a lower-tier partnership—that is, a partnership in which the partnership that received the notice of FPAA owns an interest—are included in the FPAA of the partnership before us, we are without jurisdiction to determine those lower-tier partnership items.” Order, at p. 2. (Citations omitted).

The Philippians’ trusty attorney folds.

Oh, the footnote? “TEFRA was repealed by the Bipartisan Budget Act of 2015, Pub. L. No. 114-74, §1101(a), 129 Stat. 584, 625.” Order, at p. 2, footnote 3.

It will be interesting to see how a case like this plays out under the new regime. As both partnership items and partner items are to be dealt with in a one-size-fits-all proceeding, will tiers still bar partners in upper-tier partnerships from contesting lower-tier items?

There’s much ado just now anent Artificial Intelligence (AI). Many ask if it is a boon or a bane. Will use thereof corrupt the public mind, so that falsehoods too easily assume the guise of truths? Or will it act positively, to expand communication and reduce to manageable proportions the data deluge which now overwhelms us?

FIIK, says I, but however adroit the machine or mechanics, trust the human being to overcome whatever it is, even without the addition of AI.

Here’s Elwin A. Abarca, Docket No. 31754-21L, filed 6/30/23, but Elwin is just an innocent bystander, as are his three (count ’em, three) trusty attorneys. The protagonist is IRS’ trusty counsel, whom I’ll call Mel.

And I’ll let Judge Courtney D. (“CD”) Jones tell the tale. The dates are left in, as they’re relevant.

“On June 8, 2023, respondent filed a Motion for Continuance (Motion) (Doc. 12). In response to the Motion, the Court noted a lack of clarity in the Motion regarding whether the reference to Special Trial Judge Choi was intentional or merely a typographical error (Doc. 13). Accordingly, the Court directed respondent to file a clarifying amendment.

“On June 28, 2023, respondent filed a First Amendment to Motion for Continuance (First Amendment) (Doc. 14). Unfortunately, respondent’s First Amendment suffers from the same lack of clarity from which the Motion suffers. While the First Amendment provides that ‘respondent’s counsel erred by requesting that jurisdiction be retained by Judge Choi for this proceeding” (Par. 2), it goes on to request that ‘the case be continued…with jurisdiction retained by Judge Choi Jones…” (Par. 3).” Ordre, at p. 1.

Motion denied without prejudice to refile.

Oi choi oi, as we used to say.

You might like to be there, whether in a tournament or in a cash game, but Glade Creek Partners, LLC, Sequatchie Holdings, LLC, Tax Matters Partner, T.C. Memo. 2023-82, filed 6/29/23, is not happy sitting there, because being “on the button” is being the dealer. And that’s how Judge Goeke treats them in this Supplemental Memorandum Opinion.

The Glade Creek crew are back from 11 Cir, which Hewitted IRS’ extinguishment proceeds argument; it’s invalid per APA. IRS concedes the easement is valid. 11 Cir sustained Judge Goeke’s finding that FMV of the easement is $8,877,771. So how is the value to be divided among the syndicate?

BTW, for Judge Goeke’s original opinion, see my blogpost “So It’s Not Perpetual,” 11/2/20.

Granted some number is deductible. Is it the FMV above set forth, or the deductible amount limited to the basis in Glade Creek’s hands when easement granted? In short, was the property itself held for investment, or inventory when the Glade Creek crew acquired it? If the latter, Section 724(b) locks in that status for five (count ’em, five) years from acquisition. “This provision was enacted to prevent conversion of a partner’s ordinary income property into capital gain property by contributing it to a partnership that has a different purpose for owning the property.” T. C. Memo. 2023-82, at p. 9.

The property is TN where-the-blacktop-ends. It was a vacation home PUD that fizzled in The Black ’08. The prior owner (Hawks Bluff) had land use approval for three tracts, but only filed for one, to save real estate taxes. The Black ’08 killed the one after a couple sales (hi, Judge Holmes) so they syndicated the remaining two “to protect the natural beauty of the land in a manner consistent with the original vision for a master-planned community and would protect the future development of the unsold lots on tract I,” T. C. Memo. 2023-82, at p. 5, and maybe also to stave off the seller-mortgagee.

Glade Creek had a $3.8 million basis in the property at acquisition.

So it’s back to the numbers, but we don’t need no appraisals this time.

IRS “…argues that under section 724(b) the amount of the easement deduction is limited to the part of Glade Creek’s adjusted basis in the easement property that is allocable to the easement determined by the ratio of the fair market value of the easement over the fair market value of the unencumbered easement property ($8,877,771/$9,354,171) multiplied by Glade Creek’s adjusted basis in the easement property ($3,861,316), for a deduction of $3,664,622. See Treas. Reg. § 1.170A-14(h)(3)(iii).” T. C. Memo. 2023-82, at p. 9. (Footnote omitted).

Of course, Glade Creek claims Hawks Bluff held that property for investment, hence capital asset.

11 Cir’s factors for determining capital vs inventory mostly deal with selling activity, and there wasn’t any as to this part of the property, but that’s not conclusive.

Hawks Bluff reported the transfer as inventory, and took an ordinary loss. And while a dealer can hold property for investment as well as inventory, it must be segregated; and merely doing nothing is insufficient.

The trial testimony is equivocal. And Hawks Bluff’s predecessor certainly didn’t hold the property for investment; they started their pre-development work straight away. There was no sign Hawks Bluff expected the property to appreciate any time soon. The fallout from The Black ’08 saw to that.

Section 724(b) limits the deduction.

The fallout from TEFRA goes on apace, as American Milling, LP, UN Limited, Tax Matters Partner, T.C. Memo. 2023-83, filed 6/29/23, makes a return engagement with Judge Pugh. I won’t fault you if you don’t remember this Son-of-BOSS with tugboats; its’s been a wee while, like about eight (count ’em, eight) years. See my blogpost “Jumping Through the Mill,” 9/28/15.

All that’s left now is whether SOL has run on David Jump, an indirect partner in Milling. You’ll recall that Milling got nailed in USDCSDIL for the shenanigans, but not for the chops. Then Milling got into the Tax Court scrimmage described in my blogpost above cited. But IRS never hit Dave with the deficiencies from the blow-up of the tugboat dodge in the Section 6229(a) three year plus court time plus one year SOL extension. So Dave claims SOL.

IRS claims they’re OK because Section 6229(e) gives extra time from when the indirect partner’s identity is given to IRS. And IRS concedes Section 6501(c)(10) doesn’t apply. IRS further claims that, as there were separate FPAAs for both Milling and Boat (the counterparty in the phony partnership), the Section 6229(e) one-year add-on to SOL runs from Boat FPAA, which was later than Milling.

Except.

“Respondent’s argument works only if we can ignore the Milling FPAA and treat the partnership items in it as affected items of American Milling. The parties do not dispute that the American Boat FPAA was issued within the prescribed limitations period, and they do not dispute that the Milling FPAA was not. Their argument focuses specifically on which FPAA counts for purposes of section 6229(e)(2).” T. C. Memo. 2023-83, at p. 9.

Problem is, the same item cannot be both a partnership item and an affected item (partner level) in the same entity. Remember, IRS won back in 2015 by showing that there were separate  FPAAs for Milling and Boat, not duplicates of the same FPAA, which Section 6223(f) prohibits absent fraud, and no one claimed fraud.  Wherefore, the item in question wasn’t an affected item for Milling that flowed through to Milling as a partner of Boat, but a Milling partnership item. So now IRS can’t claim that item is an affected item in order to nail Dave at this late date.

“Respondent in American Milling I convinced us that the adjustments in the Milling FPAA were partnership items of American Milling, not merely affected items flowing from American Boat through American Milling ultimately to Mr. Jump. Now, to satisfy section 6229(e)(2)(A), respondent asks us to conclude that the same items are also affected items of American Milling. But if that were the case, then they would be determined at the partner level (that is, Mr. Jump’s level) and this TEFRA partnership-level proceeding would not be necessary or appropriate. Respondent cannot have it both ways.” T. C. Memo. 2023-83, at p. 10.

IRS claims Dave and Boat reported inconsistently and never filed Form 8082, so Section 6229(e)(2)(B) kept the SOL open. Judge Pugh says Boat is irrelevant.

“Under the plain wording of the statute, we must consider the partnership items that flow to Mr. Jump. Those were American Milling’s partnership items determined in the Milling FPAA. Because Mr. Jump did not file inconsistently from American Milling, section 6229(e)(2)(B) did not keep the period of limitations open with respect to Mr. Jump when the Milling FPAA was issued.” T. C. Memo. 2023-83, at p. 12.

IRS is SOL on SOL. A Taishoff “Good Job” to Dave’s trusty attorneys, whom I’ll call Tough Tony and JPT.

And now you see why I don’t mourn TEFRA.

Donald E. Swanson, T.C. Memo. 2023-81, filed 6/29/23, retired from loading cargo and driving a city bus, and went fishing.. He had thirty (count ’em, thirty) happy years of fishing in AK, so he started a charter fishing operation. Don had health issues, but they were treated and didn’t keep him from his skipper role.

Don may have been a good fisherman, but a bad bookkeeper. Judge Pugh finds fault with Don’s lack of records several times, and sustains IRS’ bank deposits analysis. Don had rental income and got paid for doing some tax prep work.

Judge Pugh does the obligatory trudge through Reg. Section 1.183-2(b), the famous “goofy regulation” so-called by the late Judge Richard Posner and exhaustively cataloged by my colleague Peter Reilly, CPA.

As is common,  it’s the lack of records and no separate bank account for the fishing operation that sink Don’s fishing expeditions. Without records, how can an operator decide what strategies are unprofitable, and correct or eliminate them? Not only must one have records, but use them.

Merely taking steps to comply with local law, like getting a commercial fishing license and commercial insurance, isn’t enough. You’re not businesslike if the losses just keep on coming and you make no changes to your operations. And despite losses you buy an airplane and run up more losses.

Don was represented by Christopher Crago, Esq., and his students from the Zag LITC (that’s Gonzaga University School of Law Low Income Tax Clinic). Tough case.